10-Q 1 ace-6302014x10q.htm 10-Q ACE-6.30.2014-10Q
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
þ
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended June 30, 2014

OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Transition Period from             to             
Commission File No. 1-11778
ACE LIMITED
(Exact name of registrant as specified in its charter)

Switzerland
98-0091805
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)

Baerengasse 32
Zurich, Switzerland CH-8001
(Address of principal executive offices) (Zip Code)
+41 (0)43 456 76 00
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
YES þ                                                 NO  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
YES þ                                                 NO  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer þ
 
 
 
 
 
Accelerated filer ¨
Non-accelerated filer  ¨
(Do not check if a smaller reporting company)
 
Smaller reporting company ¨ 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
YES ¨                                                NO  þ
The number of registrant’s Common Shares (CHF 26.01 par value) outstanding as of July 16, 2014 was 335,698,995.


ACE LIMITED
INDEX TO FORM 10-Q
 
 
 
 
Page
Part I.
FINANCIAL INFORMATION
 
Item 1.
 
 
 
 
              Six Months Ended June 30, 2014 and 2013
 
              Six Months Ended June 30, 2014 and 2013
 
 
 
Note 1.
 
Note 2.
 
Note 3.
 
Note 4.
 
Note 5.
 
Note 6.
 
Note 7.
 
Note 8.
 
Note 9.
 
Note 10.
 
Note 11.
 
Note 12.
Item 2.
Item 3.
Item 4.
 
 
 
Part II.
OTHER INFORMATION
 
Item 1.
Item 1A.
Item 2.
Item 6.



2

PART I FINANCIAL INFORMATION

ITEM 1. Financial Statements

CONSOLIDATED BALANCE SHEETS (Unaudited)
ACE Limited and Subsidiaries
 
June 30

 
December 31

(in millions of U.S. dollars, except share and per share data)
2014

 
2013

Assets
 
 
 
Investments
 
 
 
Fixed maturities available for sale, at fair value (amortized cost – $49,719 and $48,406)
$
51,601

 
$
49,254

    (includes hybrid financial instruments of $305 and $302)
Fixed maturities held to maturity, at amortized cost (fair value – $6,015 and $6,263)
5,774

 
6,098

Equity securities, at fair value (cost – $874 and $841)
907

 
837

Short-term investments, at fair value and amortized cost
2,108

 
1,763

Other investments (cost – $2,876 and $2,671)
3,230

 
2,976

Total investments
63,620

 
60,928

Cash
594

 
579

Securities lending collateral
1,440

 
1,632

Accrued investment income
556

 
556

Insurance and reinsurance balances receivable
5,316

 
5,026

Reinsurance recoverable on losses and loss expenses
10,768

 
11,227

Reinsurance recoverable on policy benefits
234

 
218

Deferred policy acquisition costs
2,562

 
2,313

Value of business acquired
514

 
536

Goodwill and other intangible assets
5,522

 
5,404

Prepaid reinsurance premiums
1,867

 
1,675

Deferred tax assets
234

 
616

Investments in partially-owned insurance companies
470

 
470

Other assets
3,750

 
3,330

Total assets
$
97,447

 
$
94,510

Liabilities
 
 
 
Unpaid losses and loss expenses
$
37,177

 
$
37,443

Unearned premiums
8,296

 
7,539

Future policy benefits
4,778

 
4,615

Insurance and reinsurance balances payable
3,794

 
3,628

Securities lending payable
1,441

 
1,633

Accounts payable, accrued expenses, and other liabilities
5,419

 
4,810

Short-term debt
1,851

 
1,901

Long-term debt
4,057

 
3,807

Trust preferred securities
309

 
309

Total liabilities
67,122

 
65,685

Commitments and contingencies

 

Shareholders’ equity
 
 
 
Common Shares (CHF 26.01 and CHF 27.04 par value; 342,832,412 shares issued; 336,225,589 and 339,793,935 shares outstanding)
8,501

 
8,899

Common Shares in treasury (6,606,823 and 3,038,477 shares)
(630
)
 
(255
)
Additional paid-in capital
5,055

 
5,238

Retained earnings
15,304

 
13,791

Accumulated other comprehensive income (AOCI)
2,095

 
1,152

Total shareholders’ equity
30,325

 
28,825

Total liabilities and shareholders’ equity
$
97,447

 
$
94,510

See accompanying notes to the consolidated financial statements


3

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (Unaudited)
ACE Limited and Subsidiaries

 
Three Months Ended
 
 
Six Months Ended
 
 
June 30
 
 
June 30
 
(in millions of U.S. dollars, except per share data)
2014

 
2013

 
2014

 
2013

Revenues
 
 
 
 
 
 
 
Net premiums written
$
4,559

 
$
4,391

 
$
8,744

 
$
8,189

Increase in unearned premiums
(227
)
 
(324
)
 
(442
)
 
(549
)
Net premiums earned
4,332

 
4,067

 
8,302

 
7,640

Net investment income
556

 
534

 
1,109

 
1,065

Net realized gains (losses):
 
 
 
 

 
 
Other-than-temporary impairment (OTTI) losses gross
(13
)
 
(7
)
 
(25
)
 
(10
)
Portion of OTTI losses recognized in other comprehensive income (OCI)
1

 
—

 
2

 
—

Net OTTI losses recognized in income
(12
)
 
(7
)
 
(23
)
 
(10
)
Net realized gains (losses) excluding OTTI losses
(61
)
 
111

 
(154
)
 
320

Total net realized gains (losses) (includes $21, $38, $27, and $73 reclassified from AOCI)
(73
)
 
104

 
(177
)
 
310

Total revenues
4,815

 
4,705

 
9,234

 
9,015

Expenses
 
 
 
 
 
 
 
Losses and loss expenses
2,388

 
2,250

 
4,549

 
4,176

Policy benefits
144

 
110

 
258

 
241

Policy acquisition costs
758

 
665

 
1,486

 
1,279

Administrative expenses
566

 
564

 
1,101

 
1,078

Interest expense
72

 
73

 
143

 
133

Other (income) expense
(25
)
 
37

 
(42
)
 
27

Total expenses
3,903

 
3,699

 
7,495

 
6,934

Income before income tax
912

 
1,006

 
1,739

 
2,081

Income tax expense (includes $5, $7, $2, and $12 of reclassified unrealized gains)
133

 
115

 
226

 
237

Net income
$
779

 
$
891

 
$
1,513

 
$
1,844

Other comprehensive income (loss)
 
 
 
 
 
 
 
Unrealized appreciation (depreciation)
$
589

 
$
(1,470
)
 
$
1,108

 
$
(1,586
)
Reclassification adjustment for net realized gains included in net income
(21
)
 
(38
)
 
(27
)
 
(73
)
 
568

 
(1,508
)
 
1,081

 
(1,659
)
Change in:
 
 
 
 
 
 
 
Cumulative translation adjustment
153

 
(175
)
 
120

 
(386
)
Pension liability
(5
)
 
(3
)
 
(13
)
 
19

Other comprehensive income (loss), before income tax
716

 
(1,686
)
 
1,188

 
(2,026
)
Income tax (expense) benefit related to OCI items
(147
)
 
296

 
(245
)
 
399

Other comprehensive income (loss)
569

 
(1,390
)
 
943

 
(1,627
)
Comprehensive income (loss)
$
1,348

 
$
(499
)
 
$
2,456

 
$
217

Earnings per share
 
 
 
 
 
 
 
Basic earnings per share
$
2.30

 
$
2.61

 
$
4.47

 
$
5.41

Diluted earnings per share
$
2.28

 
$
2.59

 
$
4.43

 
$
5.36

See accompanying notes to the consolidated financial statements


4

CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (Unaudited)
ACE Limited and Subsidiaries

 
Six Months Ended
 
 
June 30
 
(in millions of U.S. dollars)
2014

 
2013

Common Shares
 
 
 
Balance – beginning of period
$
8,899

 
$
9,591

Dividends declared on Common Shares – par value reduction
(398
)
 
(342
)
Balance – end of period
8,501

 
9,249

Common Shares in treasury
 
 
 
Balance – beginning of period
(255
)
 
(159
)
Common Shares repurchased
(569
)
 
(212
)
Net shares redeemed under employee share-based compensation plans
194

 
152

Balance – end of period
(630
)
 
(219
)
Additional paid-in capital
 
 
 
Balance – beginning of period
5,238

 
5,179

Net shares redeemed under employee share-based compensation plans
(169
)
 
(128
)
Exercise of stock options
(33
)
 
(28
)
Share-based compensation expense and other
100

 
105

Funding of dividends declared to Retained earnings
(81
)
 
—

Balance – end of period
5,055

 
5,128

Retained earnings
 
 
 
Balance – beginning of period
13,791

 
10,033

Net income
1,513

 
1,844

Funding of dividends declared from Additional paid-in capital
81

 
—

Dividends declared on Common Shares
(81
)
 
—

Balance – end of period
15,304

 
11,877

Accumulated other comprehensive income
 
 
 
Net unrealized appreciation on investments
 
 
 
Balance – beginning of period
1,174

 
2,633

Change in period, before reclassification from AOCI, net of income tax (expense) benefit of $(210) and $332
898

 
(1,254
)
Amounts reclassified from AOCI, net of income tax benefit of $2 and $12
(25
)
 
(61
)
Change in period, net of income tax (expense) benefit of $(208) and $344
873

 
(1,315
)
Balance – end of period
2,047

 
1,318

Cumulative translation adjustment
 
 
 
Balance – beginning of period
63

 
339

Change in period, net of income tax (expense) benefit of $(42) and $62
78

 
(324
)
Balance – end of period
141

 
15

Pension liability adjustment
 
 
 
Balance – beginning of period
(85
)
 
(85
)
Change in period, net of income tax (expense) benefit of $5 and $(7)
(8
)
 
12

Balance – end of period
(93
)
 
(73
)
Accumulated other comprehensive income
2,095

 
1,260

Total shareholders’ equity
$
30,325

 
$
27,295

See accompanying notes to the consolidated financial statements


5

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
ACE Limited and Subsidiaries


 
Six Months Ended
 
 
June 30
 
(in millions of U.S. dollars)
2014

 
2013

Cash flows from operating activities
 
 
 
Net income
$
1,513

 
$
1,844

Adjustments to reconcile net income to net cash flows from operating activities

 

Net realized (gains) losses
177

 
(310
)
Amortization of premiums/discounts on fixed maturities
115

 
134

Deferred income taxes
117

 
98

Unpaid losses and loss expenses
(493
)
 
(304
)
Unearned premiums
594

 
693

Future policy benefits
139

 
117

Insurance and reinsurance balances payable
142

 
182

Accounts payable, accrued expenses, and other liabilities
37

 
230

Income taxes payable
(56
)
 
20

Insurance and reinsurance balances receivable
(244
)
 
(611
)
Reinsurance recoverable on losses and loss expenses
546

 
538

Reinsurance recoverable on policy benefits
(14
)
 
2

Deferred policy acquisition costs
(228
)
 
(268
)
Prepaid reinsurance premiums
(171
)
 
(179
)
Other
(78
)
 
(378
)
Net cash flows from operating activities
2,096

 
1,808

Cash flows from investing activities
 
 
 
Purchases of fixed maturities available for sale
(7,960
)
 
(10,778
)
Purchases of to be announced mortgage-backed securities
—

 
(26
)
Purchases of fixed maturities held to maturity
(129
)
 
(299
)
Purchases of equity securities
(64
)
 
(194
)
Sales of fixed maturities available for sale
3,842

 
5,370

Sales of to be announced mortgage-backed securities
—

 
26

Sales of equity securities
45

 
62

Maturities and redemptions of fixed maturities available for sale
3,163

 
4,112

Maturities and redemptions of fixed maturities held to maturity
414

 
908

Net change in short-term investments
(295
)
 
(137
)
Net derivative instruments settlements
(185
)
 
(317
)
Acquisition of subsidiaries (net of cash acquired of $4 and $38)
(172
)
 
(977
)
Other
(118
)
 
(126
)
Net cash flows used for investing activities
(1,459
)
 
(2,376
)
Cash flows from financing activities
 
 
 
Dividends paid on Common Shares
(428
)
 
(169
)
Common Shares repurchased
(557
)
 
(212
)
Proceeds from issuance of long-term debt
699

 
947

Proceeds from issuance of short-term debt
977

 
1,570

Repayment of long-term debt
(500
)
 
—

Repayment of short-term debt
(977
)
 
(1,570
)
Proceeds from share-based compensation plans, including windfall tax benefits
75

 
62

Other
86

 
30

Net cash flows (used for) from financing activities
(625
)
 
658

Effect of foreign currency rate changes on cash and cash equivalents
3

 
(26
)
Net increase in cash
15

 
64

Cash – beginning of period
579

 
615

Cash – end of period
$
594

 
$
679

Supplemental cash flow information
 
 
 
Taxes paid
$
148

 
$
88

Interest paid
$
134

 
$
117

See accompanying notes to the consolidated financial statements


6

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
ACE Limited and Subsidiaries



1. General

Basis of presentation
ACE Limited is a holding company incorporated in Zurich, Switzerland. ACE Limited, through its subsidiaries, provides a broad range of insurance and reinsurance products to insureds worldwide. ACE operates through five business segments: Insurance – North American P&C, Insurance – North American Agriculture, Insurance – Overseas General, Global Reinsurance, and Life. Refer to Note 10 for additional information.

The interim unaudited consolidated financial statements, which include the accounts of ACE Limited and its subsidiaries (collectively, ACE, we, us, or our), have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) and, in the opinion of management, reflect all adjustments (consisting of normally recurring accruals) necessary for a fair statement of the results and financial position for such periods. All significant intercompany accounts and transactions have been eliminated.

The results of operations and cash flows for any interim period are not necessarily indicative of the results for the full year. These consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes included in our 2013 Form 10-K.

2. Acquisitions

Large Corporate P&C Insurance Business of Itaú Seguros, S.A. (Itaú Seguros)
On July 4, 2014, we announced that we reached a definitive agreement to acquire the large corporate property and casualty (P&C) insurance business of Itaú Seguros, Brazil's leading carrier for that business, for approximately $685 million, at current exchange rates. This transaction, which is subject to regulatory approval and other customary closing conditions, is expected to be completed in the first quarter of 2015.
  
The Siam Commercial Samaggi Insurance PCL (Samaggi)
We and our local partner acquired 60.86 percent of Samaggi, a general insurance company in Thailand, from Siam Commercial Bank on April 28, 2014, and subsequently acquired an additional 32.17 percent ownership, through a mandatory tender offer, which expired on June 17, 2014. The purchase price for 93.03 percent of the company was $176 million in cash. This acquisition expands our presence in Thailand and Southeast Asia.

The acquisition generated $46 million of goodwill, attributable to expected growth and profitability, none of which is expected to be deductible for income tax purposes, and other intangible assets of $80 million based on ACE’s preliminary purchase price allocation.  The other intangible assets primarily relate to a bancassurance agreement. Goodwill and other intangible assets arising from this acquisition are included in the Insurance – Overseas General segment.

ABA Seguros
On May 2, 2013, we acquired ABA Seguros, a property and casualty insurer in Mexico that provides automobile, homeowners, and small business coverages for approximately $690 million in cash.

The acquisition generated $285 million of goodwill, attributable to expected growth and profitability, none of which is expected to be deductible for income tax purposes, and other intangible assets of $140 million based on ACE’s purchase price allocation. The other intangible assets primarily relate to distribution channels. Amortization of other intangible assets is included in Other (income) expense in the consolidated statements of operations. Goodwill and other intangible assets arising from this acquisition are included in the Insurance – Overseas General segment.

Fianzas Monterrey
On April 1, 2013, we acquired Fianzas Monterrey, a leading surety lines company in Mexico offering administrative performance bonds primarily to clients in the construction and industrial sectors, for approximately $293 million in cash. This acquisition greatly expanded our global franchise in the surety business and enhanced our existing commercial lines and personal accident insurance business in Mexico.

The acquisition generated $137 million of goodwill, attributable to expected growth and profitability, none of which is expected to be deductible for income tax purposes, and other intangible assets of $73 million, based on ACE's purchase price allocation. The other intangible assets primarily relate to customer lists. Amortization of other intangible assets is included in Other


7

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – continued (Unaudited)
ACE Limited and Subsidiaries


(income) expense in the consolidated statements of operations. Goodwill and other intangible assets arising from this acquisition are included in the Insurance – Overseas General segment.


3. Investments

a) Fixed maturities
 
June 30, 2014
Amortized
Cost

 
Gross
Unrealized
Appreciation

 
Gross
Unrealized
Depreciation

 
Fair
Value

 
OTTI Recognized
in AOCI

(in millions of U.S. dollars)
 
 
 
 
Available for sale
 
 
 
 
 
 
 
 
 
U.S. Treasury and agency
$
2,806

 
$
80

 
$
(17
)
 
$
2,869

 
$
—

Foreign
15,084

 
563

 
(38
)
 
15,609

 
(1
)
Corporate securities
17,085

 
981

 
(36
)
 
18,030

 
(3
)
Mortgage-backed securities
11,185

 
308

 
(75
)
 
11,418

 
(10
)
States, municipalities, and political subdivisions
3,559

 
131

 
(15
)
 
3,675

 
—

 
$
49,719

 
$
2,063

 
$
(181
)
 
$
51,601

 
$
(14
)
Held to maturity
 
 
 
 
 
 
 
 
 
U.S. Treasury and agency
$
779

 
$
18

 
$
(2
)
 
$
795

 
$
—

Foreign
809

 
44

 
—

 
853

 
—

Corporate securities
1,828

 
101

 
—

 
1,929

 
—

Mortgage-backed securities
1,187

 
54

 
—

 
1,241

 
—

States, municipalities, and political subdivisions
1,171

 
31

 
(5
)
 
1,197

 
—

 
$
5,774

 
$
248

 
$
(7
)
 
$
6,015

 
$
—


December 31, 2013
Amortized
Cost

 
Gross
Unrealized
Appreciation

 
Gross
Unrealized
Depreciation

 
Fair
Value

 
OTTI Recognized
in AOCI

(in millions of U.S. dollars)
 
 
 
 
Available for sale
 
 
 
 
 
 
 
 
 
U.S. Treasury and agency
$
2,946

 
$
62

 
$
(59
)
 
$
2,949

 
$
—

Foreign
14,336

 
377

 
(122
)
 
14,591

 
—

Corporate securities
16,825

 
777

 
(132
)
 
17,470

 
(6
)
Mortgage-backed securities
10,937

 
184

 
(227
)
 
10,894

 
(34
)
States, municipalities, and political subdivisions
3,362

 
65

 
(77
)
 
3,350

 
—

 
$
48,406

 
$
1,465

 
$
(617
)
 
$
49,254

 
$
(40
)
Held to maturity
 
 
 
 
 
 
 
 
 
U.S. Treasury and agency
$
820

 
$
16

 
$
(4
)
 
$
832

 
$
—

Foreign
864

 
33

 
—

 
897

 
—

Corporate securities
1,922

 
83

 
—

 
2,005

 
—

Mortgage-backed securities
1,341

 
39

 
(1
)
 
1,379

 
—

States, municipalities, and political subdivisions
1,151

 
16

 
(17
)
 
1,150

 
—

 
$
6,098

 
$
187

 
$
(22
)
 
$
6,263

 
$
—


As discussed in Note 3 c), if a credit loss is indicated on an impaired fixed maturity, an OTTI is considered to have occurred and the portion of the impairment not related to credit losses (non-credit OTTI) is recognized in OCI. Included in the “OTTI Recognized in AOCI” columns above are the cumulative amounts of non-credit OTTI recognized in OCI adjusted for subsequent sales, maturities, and redemptions. OTTI recognized in AOCI does not include the impact of subsequent changes in fair value of the related securities. In periods subsequent to a recognition of OTTI in OCI, changes in the fair value of the related fixed


8

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – continued (Unaudited)
ACE Limited and Subsidiaries


maturities are reflected in Unrealized appreciation (depreciation) in the consolidated statement of shareholders’ equity. For the three and six months ended June 30, 2014, $1 million and $5 million, respectively, of net unrealized appreciation related to such securities is included in OCI. For the three and six months ended June 30, 2013, $1 million and $25 million, respectively, of net unrealized appreciation related to such securities is included in OCI. At June 30, 2014 and December 31, 2013, AOCI includes cumulative net unrealized depreciation of $1 million and $4 million, respectively, related to securities remaining in the investment portfolio at those dates for which ACE has recognized a non-credit OTTI.

Mortgage-backed securities (MBS) issued by U.S. government agencies are combined with all other to be announced mortgage derivatives held (refer to Note 7 a) (iv)) and are included in the category, “Mortgage-backed securities”. Approximately 83 percent of the total mortgage-backed securities at June 30, 2014 and December 31, 2013 are represented by investments in U.S. government agency bonds. The remainder of the mortgage exposure consists of collateralized mortgage obligations and non-government mortgage-backed securities, the majority of which provide a planned structure for principal and interest payments and carry a rating of AAA by the major credit rating agencies.

The following table presents fixed maturities by contractual maturity:
 
 
 
June 30

 
 
 
December 31

 
 
 
2014

 
 
 
2013

(in millions of U.S. dollars)
Amortized Cost

 
Fair Value

 
Amortized Cost

 
Fair Value

Available for sale
 
 
 
 
 
 
 
Due in 1 year or less
$
2,513

 
$
2,537

 
$
2,387

 
$
2,411

Due after 1 year through 5 years
15,095

 
15,692

 
14,139

 
14,602

Due after 5 years through 10 years
15,917

 
16,575

 
16,200

 
16,535

Due after 10 years
5,009

 
5,379

 
4,743

 
4,812

 
38,534

 
40,183

 
37,469

 
38,360

Mortgage-backed securities
11,185

 
11,418

 
10,937

 
10,894

 
$
49,719

 
$
51,601

 
$
48,406

 
$
49,254

Held to maturity
 
 
 
 
 
 
 
Due in 1 year or less
$
483

 
$
489

 
$
401

 
$
405

Due after 1 year through 5 years
2,590

 
2,693

 
2,284

 
2,363

Due after 5 years through 10 years
1,157

 
1,206

 
1,686

 
1,723

Due after 10 years
357

 
386

 
386

 
393

 
4,587

 
4,774

 
4,757

 
4,884

Mortgage-backed securities
1,187

 
1,241

 
1,341

 
1,379

 
$
5,774

 
$
6,015

 
$
6,098

 
$
6,263


Expected maturities could differ from contractual maturities because borrowers may have the right to call or prepay obligations, with or without call or prepayment penalties. 

b) Equity securities
 
June 30


December 31

(in millions of U.S. dollars)
2014


2013

Cost
$
874

 
$
841

Gross unrealized appreciation
77

 
63

Gross unrealized depreciation
(44
)
 
(67
)
Fair value
$
907

 
$
837


c) Net realized gains (losses)
In accordance with guidance related to the recognition and presentation of OTTI, when an impairment related to a fixed maturity has occurred, OTTI is required to be recorded in Net income if management has the intent to sell the security or it is more likely


9

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – continued (Unaudited)
ACE Limited and Subsidiaries


than not that we will be required to sell the security before the recovery of its amortized cost. Further, in cases where we do not intend to sell the security and it is more likely than not that we will not be required to sell the security, ACE must evaluate the security to determine the portion of the impairment, if any, related to credit losses. If a credit loss is indicated, an OTTI is considered to have occurred and any portion of the OTTI related to credit losses must be reflected in Net income while the portion of OTTI related to all other factors is recognized in OCI. For fixed maturities held to maturity, OTTI recognized in OCI is accreted from AOCI to the amortized cost of the fixed maturity prospectively over the remaining term of the securities.

Each quarter, securities in an unrealized loss position (impaired securities), including fixed maturities, securities lending collateral, equity securities, and other investments, are reviewed to identify impaired securities to be specifically evaluated for a potential OTTI.

For all non-fixed maturities, OTTI is evaluated based on the following:

•
the amount of time a security has been in a loss position and the magnitude of the loss position;
•
the period in which cost is expected to be recovered, if at all, based on various criteria including economic conditions and other issuer-specific developments; and
•
ACE’s ability and intent to hold the security to the expected recovery period.

As a general rule, we also consider that equity securities in an unrealized loss position for twelve consecutive months are other than temporarily impaired. For mutual funds included in equity securities in our consolidated balance sheet, we employ analysis similar to fixed maturities, when applicable.

We review each fixed maturity in an unrealized loss position to assess whether the security is a candidate for credit loss. Specifically, we consider credit rating, market price, and issuer-specific financial information, among other factors, to assess the likelihood of collection of all principal and interest as contractually due. Securities for which we determine that credit loss is likely are subjected to further analysis to estimate the credit loss recognized in Net income, if any. In general, credit loss recognized in Net income equals the difference between the security’s amortized cost and the net present value of its projected future cash flows discounted at the effective interest rate implicit in the debt security. All significant assumptions used in determining credit losses are subject to change as market conditions evolve.

Projected cash flows for corporate securities (principally senior unsecured bonds) are driven primarily by assumptions regarding probability of default and also the timing and amount of recoveries associated with defaults. ACE developed projected cash flows for corporate securities using market observable data, issuer-specific information, and credit ratings. We use historical default data by Moody’s Investors Service (Moody’s) rating category to calculate a 1-in-100 year probability of default, which results in a default assumption in excess of the historical mean default rate. Consistent with management's approach, ACE assumed a 32 percent recovery rate (the par value of a defaulted security that will be recovered) across all rating categories rather than using Moody's historical mean recovery rate of 42 percent. We believe that use of a default assumption in excess of the historical mean is conservative in light of current market conditions.

For the three and six months ended June 30, 2014, credit losses recognized in Net income for corporate securities were $6 million and $10 million, respectively. For the three and six months ended June 30, 2013, credit losses recognized in Net income for corporate securities were $6 million and $7 million, respectively.

For mortgage-backed securities, credit impairment is assessed using a cash flow model that estimates the cash flows on the underlying mortgages, using the security-specific collateral and transaction structure. The model estimates cash flows from the underlying mortgage loans and distributes those cash flows to various tranches of securities, considering the transaction structure and any subordination and credit enhancements that exist in that structure. The cash flow model incorporates actual cash flows on the mortgage-backed securities through the current period and then projects the remaining cash flows using a number of assumptions, including default rates, prepayment rates, and loss severity rates (the par value of a defaulted security that will not be recovered) on foreclosed properties.

For the three and six months ended June 30, 2014 and 2013, there were no credit losses recognized in Net income for mortgage-backed securities.


10

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – continued (Unaudited)
ACE Limited and Subsidiaries


The following table presents the Net realized gains (losses) and the losses included in Net realized gains (losses) and OCI as a result of conditions which caused us to conclude the decline in fair value of certain investments was “other-than-temporary”: 
 
Three Months Ended
 
 
Six Months Ended
 
 
June 30
 
 
June 30
 
(in millions of U.S. dollars)
2014

 
2013

 
2014

 
2013

Fixed maturities:
 
 
 
 
 
 
 
OTTI on fixed maturities, gross
$
(9
)
 
$
(6
)
 
$
(15
)
 
$
(7
)
OTTI on fixed maturities recognized in OCI (pre-tax)
1

 
—

 
2

 
—

OTTI on fixed maturities, net
(8
)
 
(6
)
 
(13
)
 
(7
)
Gross realized gains excluding OTTI
54

 
64

 
90

 
126

Gross realized losses excluding OTTI
(26
)
 
(27
)
 
(46
)
 
(52
)
Total fixed maturities
20

 
31

 
31

 
67

Equity securities:
 
 
 
 
 
 
 
OTTI on equity securities
(1
)
 
—

 
(7
)
 
(1
)
Gross realized gains excluding OTTI
2

 
8

 
4

 
10

Gross realized losses excluding OTTI
—

 
(1
)
 
(1
)
 
(3
)
Total equity securities
1

 
7

 
(4
)
 
6

OTTI on other investments
(3
)
 
(1
)
 
(3
)
 
(2
)
Foreign exchange gains (losses)
(14
)
 
(5
)
 
(23
)
 
71

Investment and embedded derivative instruments
(15
)
 
40

 
(40
)
 
58

Fair value adjustments on insurance derivative
2

 
101

 
(46
)
 
429

S&P put options and futures
(72
)
 
(68
)
 
(91
)
 
(318
)
Other derivative instruments
9

 
(1
)
 
7

 
(1
)
Other
(1
)
 
—

 
(8
)
 
—

Net realized gains (losses)
$
(73
)
 
$
104

 
$
(177
)
 
$
310

 
The following table presents a roll-forward of pre-tax credit losses related to fixed maturities for which a portion of OTTI was recognized in OCI: 
 
Three Months Ended
 
 
Six Months Ended
 
 
June 30
 
 
June 30
 
(in millions of U.S. dollars)
2014

 
2013

 
2014

 
2013

Balance of credit losses related to securities still held – beginning of period
$
35

 
$
35

 
$
37

 
$
43

Additions where no OTTI was previously recorded
5

 
4

 
7

 
4

Additions where an OTTI was previously recorded
1

 
2

 
3

 
3

Reductions for securities sold during the period
(17
)
 
(1
)
 
(23
)
 
(10
)
Balance of credit losses related to securities still held – end of period
$
24

 
$
40

 
$
24

 
$
40


d) Gross unrealized loss
At June 30, 2014, there were 3,253 fixed maturities out of a total of 25,285 fixed maturities in an unrealized loss position. The largest single unrealized loss in the fixed maturities was $3 million. There were 52 equity securities out of a total of 186 equity securities in an unrealized loss position. The largest single unrealized loss in the equity securities was $42 million. Fixed maturities in an unrealized loss position at June 30, 2014, comprised both investment grade and below investment grade securities for which fair value declined primarily due to widening credit spreads since the date of purchase. As of June 30, 2014, there was one mutual fund, classified as an equity security investment, that was in a continuous unrealized loss position for more than twelve months where an other-than-temporary loss was not recorded. The unrealized loss of $42 million was approximately 8 percent of the original cost of the related equity security. We believe the impairment was temporary based on the relative price decline of the security and our intent and ability to hold the investment to its anticipated recovery.


11

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – continued (Unaudited)
ACE Limited and Subsidiaries



The following tables present, for all securities in an unrealized loss position (including securities on loan), the aggregate fair value and gross unrealized loss by length of time the security has continuously been in an unrealized loss position:
 
0 – 12 Months
 
 
Over 12 Months
 
 
Total
 
June 30, 2014
Fair Value

 
Gross
Unrealized
Loss

 
Fair Value

 
Gross
Unrealized
Loss

 
Fair Value

 
Gross
Unrealized
Loss

(in millions of U.S. dollars)
 
 
 
 
 
U.S. Treasury and agency
$
—

 
$
—

 
$
1,069

 
$
(19
)
 
$
1,069

 
$
(19
)
Foreign
1,274

 
(11
)
 
1,303

 
(27
)
 
2,577

 
(38
)
Corporate securities
1,118

 
(12
)
 
1,050

 
(24
)
 
2,168

 
(36
)
Mortgage-backed securities
486

 
(4
)
 
2,540

 
(71
)
 
3,026

 
(75
)
States, municipalities, and political subdivisions
366

 
(4
)
 
1,041

 
(16
)
 
1,407

 
(20
)
Total fixed maturities
3,244

 
(31
)
 
7,003

 
(157
)
 
10,247

 
(188
)
Equity securities
45

 
(2
)
 
462

 
(42
)
 
507

 
(44
)
Other investments
39

 
(1
)
 
—

 
—

 
39

 
(1
)
Total
$
3,328

 
$
(34
)
 
$
7,465

 
$
(199
)
 
$
10,793

 
$
(233
)
 
 
0 – 12 Months
 
 
Over 12 Months
 
 
Total
 
December 31, 2013
Fair Value

 
Gross
Unrealized
Loss

 
Fair Value

 
Gross
Unrealized
Loss

 
Fair Value

 
Gross
Unrealized
Loss

(in millions of U.S. dollars)
 
 
 
 
 
U.S. Treasury and agency
$
1,794

 
$
(57
)
 
$
31

 
$
(6
)
 
$
1,825

 
$
(63
)
Foreign
4,621

 
(114
)
 
201

 
(8
)
 
4,822

 
(122
)
Corporate securities
3,836

 
(118
)
 
194

 
(14
)
 
4,030

 
(132
)
Mortgage-backed securities
5,248

 
(197
)
 
384

 
(31
)
 
5,632

 
(228
)
States, municipalities, and political subdivisions
2,164

 
(90
)
 
84

 
(4
)
 
2,248

 
(94
)
Total fixed maturities
17,663

 
(576
)
 
894

 
(63
)
 
18,557

 
(639
)
Equity securities
498

 
(67
)
 
—

 
—

 
498

 
(67
)
Other investments
67

 
(9
)
 
—

 
—

 
67

 
(9
)
Total
$
18,228

 
$
(652
)
 
$
894

 
$
(63
)
 
$
19,122

 
$
(715
)

e) Restricted assets
ACE is required to maintain assets on deposit with various regulatory authorities to support its insurance and reinsurance operations. These requirements are generally promulgated in the statutory regulations of the individual jurisdictions. The assets on deposit are available to settle insurance and reinsurance liabilities. ACE is also required to restrict assets pledged under repurchase agreements. We also use trust funds in certain large reinsurance transactions where the trust funds are set up for the benefit of the ceding companies and generally take the place of letter of credit (LOC) requirements. We also have investments in segregated portfolios primarily to provide collateral or guarantees for LOC and derivative transactions. Included in restricted assets at June 30, 2014 and December 31, 2013, are investments, primarily fixed maturities, totaling $15.7 billion and $16.3 billion, respectively, and cash of $84 million and $162 million, respectively.
The following table presents the components of restricted assets:
 
June 30

 
December 31

(in millions of U.S. dollars)
2014

 
2013

Trust funds
$
10,554

 
$
11,315

Deposits with non-U.S. regulatory authorities
1,969

 
1,970

Assets pledged under repurchase agreements
1,451

 
1,435

Deposits with U.S. regulatory authorities
1,336

 
1,334

Other pledged assets
459

 
391

 
$
15,769

 
$
16,445




12

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – continued (Unaudited)
ACE Limited and Subsidiaries


4. Fair value measurements

a) Fair value hierarchy
Fair value of financial assets and financial liabilities is estimated based on the framework established in the fair value accounting guidance. The guidance defines fair value as the price to sell an asset or transfer a liability (an exit price) in an orderly transaction between market participants and establishes a three-level valuation hierarchy based on the reliability of the inputs. The fair value hierarchy gives the highest priority to quoted prices in active markets and the lowest priority to unobservable data.
 
The three levels of the hierarchy are as follows:

•
Level 1 – Unadjusted quoted prices for identical assets or liabilities in active markets;
•
Level 2 – Includes, among other items, inputs other than quoted prices that are observable for the asset or liability such as
interest rates and yield curves, quoted prices for similar assets and liabilities in active markets, and quoted prices for identical or similar assets and liabilities in markets that are not active; and
•
Level 3 – Inputs that are unobservable and reflect management’s judgments about assumptions that market participants
would use in pricing an asset or liability.

We categorize financial instruments within the valuation hierarchy at the balance sheet date based upon the lowest level of inputs that are significant to the fair value measurement. Accordingly, transfers between levels within the valuation hierarchy occur when there are significant changes to the inputs, such as increases or decreases in market activity, changes to the availability of current prices, changes to the transparency to underlying inputs, and whether there are significant variances in quoted prices. Transfers in and/or out of any level are assumed to occur at the end of the period.

We use pricing services to obtain fair value measurements for the majority of our investment securities. Based on management’s understanding of the methodologies used, these pricing services only produce an estimate of fair value if there is observable market information that would allow them to make a fair value estimate. Based on our understanding of the market inputs used by the pricing services, all applicable investments have been valued in accordance with GAAP. We do not adjust prices obtained from pricing services. The following is a description of the valuation techniques and inputs used to determine fair values for financial instruments carried at fair value, as well as the general classification of such financial instruments pursuant to the valuation hierarchy.

Fixed maturities
We use pricing services to estimate fair value measurements for the majority of our fixed maturities. The pricing services use market quotations for fixed maturities that have quoted prices in active markets; such securities are classified within Level 1. For fixed maturities other than U.S. Treasury securities that generally do not trade on a daily basis, the pricing services prepare estimates of fair value measurements using their pricing applications, which include available relevant market information, benchmark curves, benchmarking of like securities, sector groupings, and matrix pricing. Additional valuation factors that can be taken into account are nominal spreads, dollar basis, and liquidity adjustments. The pricing services evaluate each asset class based on relevant market and credit information, perceived market movements, and sector news. The market inputs used in the pricing evaluation, listed in the approximate order of priority include: benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, reference data, and industry and economic events. The extent of the use of each input is dependent on the asset class and the market conditions. Given the asset class, the priority of the use of inputs may change, or some market inputs may not be relevant. Additionally, fixed maturities valuation is more subjective when markets are less liquid due to the lack of market based inputs (i.e., stale pricing), which may increase the potential that an investment's estimated fair value is not reflective of the price at which an actual transaction would occur. The overwhelming majority of fixed maturities are classified within Level 2 because the most significant inputs used in the pricing techniques are observable. For a small number of fixed maturities, we obtain a quote from a broker (typically a market maker). Due to the disclaimers on the quotes that indicate that the price is indicative only, we include these fair value estimates in Level 3. 

Equity securities
Equity securities with active markets are classified within Level 1 as fair values are based on quoted market prices. For equity securities in markets which are less active, fair values are based on market valuations and are classified within Level 2. Equity securities for which pricing is unobservable are classified within Level 3.



13

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – continued (Unaudited)
ACE Limited and Subsidiaries


Short-term investments
Short-term investments, which comprise securities due to mature within one year of the date of purchase that are traded in active markets, are classified within Level 1 as fair values are based on quoted market prices. Securities such as commercial paper and discount notes are classified within Level 2 because these securities are typically not actively traded due to their approaching maturity and, as such, their cost approximates fair value. Short-term investments for which pricing is unobservable are classified within Level 3.

Other investments
Fair values for the majority of Other investments including investments in partially-owned investment companies, investment funds, and limited partnerships are based on their respective net asset values or equivalent (NAV). The majority of these investments, for which NAV was used as a practical expedient to measure fair value, are classified within Level 3 because either ACE will never have the contractual option to redeem the investments or will not have the contractual option to redeem the investments in the near term. The remainder of such investments is classified within Level 2. Certain of our long-duration contracts are supported by assets that do not qualify for separate account reporting under GAAP. These assets comprise mutual funds classified within Level 1 in the valuation hierarchy on the same basis as other equity securities traded in active markets. Other investments also includes equity securities and fixed maturities held in rabbi trusts maintained by ACE for deferred compensation plans, which are classified within the valuation hierarchy on the same basis as other equity securities and fixed maturities.

Securities lending collateral
The underlying assets included in Securities lending collateral in the consolidated balance sheets are fixed maturities which are classified in the valuation hierarchy on the same basis as other fixed maturities. Excluded from the valuation hierarchy is the corresponding liability related to ACE’s obligation to return the collateral plus interest as it is reported at contract value and not fair value in the consolidated balance sheets.

Investment derivative instruments
Actively traded investment derivative instruments, including futures, options, and forward contracts are classified within Level 1 as fair values are based on quoted market prices. The fair value of cross-currency swaps are based on market valuations and are classified within Level 2. Investment derivative instruments are recorded in either Other assets or Accounts payable, accrued expenses, and other liabilities in the consolidated balance sheets.

Other derivative instruments
We maintain positions in other derivative instruments including exchange-traded equity futures contracts and option contracts designed to limit exposure to a severe equity market decline, which would cause an increase in expected claims and, therefore, reserves for our guaranteed minimum death benefits (GMDB) and guaranteed living benefits (GLB) reinsurance business. Our position in exchange-traded equity futures contracts is classified within Level 1. The fair value of the majority of the remaining positions in other derivative instruments is based on significant observable inputs including equity security and interest rate indices. Accordingly, these are classified within Level 2. Other derivative instruments are recorded in either Other assets or Accounts payable, accrued expenses, and other liabilities in the consolidated balance sheets.

Separate account assets
Separate account assets represent segregated funds where investment risks are borne by the customers, except to the extent of certain guarantees made by ACE. Separate account assets comprise mutual funds classified in the valuation hierarchy on the same basis as other equity securities traded in active markets and are classified within Level 1. Separate account assets also include fixed maturities classified within Level 2 because the most significant inputs used in the pricing techniques are observable. Excluded from the valuation hierarchy are the corresponding liabilities as they are reported at contract value and not fair value in the consolidated balance sheets. Separate account assets are recorded in Other assets in the consolidated balance sheets.

Guaranteed living benefits
The GLB arises from life reinsurance programs covering living benefit guarantees whereby we assume the risk of guaranteed minimum income benefits (GMIB) and guaranteed minimum accumulation benefits (GMAB) associated with variable annuity contracts. GLB’s are recorded in Accounts payable, accrued expenses, and other liabilities and Future policy benefits in the consolidated balance sheets. For GLB reinsurance, ACE estimates fair value using an internal valuation model which includes current market information and estimates of policyholder behavior. All of the treaties contain claim limits, which are factored into the valuation model. The fair value depends on a number of inputs, including changes in interest rates, changes in equity


14

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – continued (Unaudited)
ACE Limited and Subsidiaries


markets, credit risk, current account value, changes in market volatility, expected annuitization rates, changes in policyholder behavior, and changes in policyholder mortality.

The most significant policyholder behavior assumptions include lapse rates and the GMIB annuitization rates. Assumptions regarding lapse rates and GMIB annuitization rates differ by treaty, but the underlying methodologies to determine rates applied to each treaty are comparable. The assumptions regarding lapse and GMIB annuitization rates determined for each treaty are based on a dynamic calculation that uses several underlying factors.

A lapse rate is the percentage of in-force policies surrendered in a given calendar year. All else equal, as lapse rates increase, ultimate claim payments will decrease.

GMIB annuitization rate is the percentage of policies for which the policyholder will elect to annuitize using the guaranteed benefit provided under the GMIB. All else equal, as GMIB annuitization rates increase, ultimate claim payments will increase, subject to treaty claim limits.

The effect of changes in key market factors on assumed lapse and annuitization rates reflect emerging trends using data available from cedants. For treaties with limited experience, rates are established in line with data received from other ceding companies adjusted, as appropriate, with industry estimates. The model and related assumptions are continuously re-evaluated by management and enhanced, as appropriate, based upon additional experience obtained related to policyholder behavior and availability of more information, such as market conditions, market participant assumptions, and demographics of in-force annuities. During the three and six months ended June 30, 2014, no material changes were made to actuarial or behavioral assumptions. We made minor technical refinements to the model with a favorable (unfavorable) net income impact of approximately $1 million and $(2) million for the three and six months ended June 30, 2014, respectively. For detailed information on our lapse and annuitization rate assumptions, refer to Note 4 to the Consolidated Financial Statements of our 2013 Form 10-K.

We view the variable annuity reinsurance business as having a similar risk profile to that of catastrophe reinsurance, with the probability of a cumulative long-term economic net loss relatively small at the time of pricing. However, adverse changes in market factors and policyholder behavior will have an adverse impact on net income, which may be material. Because of the significant use of unobservable inputs including policyholder behavior, GLB reinsurance is classified within Level 3.


15

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – continued (Unaudited)
ACE Limited and Subsidiaries


The following tables present, by valuation hierarchy, the financial instruments measured at fair value on a recurring basis:
June 30, 2014
Level 1

 
Level 2

 
Level 3

 
Total

(in millions of U.S. dollars)
 
 
 
Assets:
 
 
 
 
 
 
 
Fixed maturities available for sale
 
 
 
 
 
 
 
U.S. Treasury and agency
$
1,677

 
$
1,192

 
$
—

 
$
2,869

Foreign
216

 
15,381

 
12

 
15,609

Corporate securities
—

 
17,826

 
204

 
18,030

Mortgage-backed securities
—

 
11,411

 
7

 
11,418

States, municipalities, and political subdivisions
—

 
3,675

 
—

 
3,675

 
1,893

 
49,485

 
223

 
51,601

Equity securities
414

 
491

 
2

 
907

Short-term investments
1,069

 
1,039

 
—

 
2,108

Other investments
336

 
254

 
2,640

 
3,230

Securities lending collateral
—

 
1,440

 
—

 
1,440

Investment derivative instruments
9

 
—

 
—

 
9

Other derivative instruments
16

 
2

 
—

 
18

Separate account assets
1,349

 
88

 
—

 
1,437

Total assets measured at fair value
$
5,086

 
$
52,799

 
$
2,865

 
$
60,750

Liabilities:
 
 
 
 
 
 
 
Investment derivative instruments
$
10

 
$
—

 
$
—

 
$
10

Other derivative instruments
15

 
2

 
—

 
17

GLB(1)
—

 
—

 
241

 
241

Total liabilities measured at fair value
$
25

 
$
2

 
$
241

 
$
268

(1) 
Our GLB reinsurance product meets the definition of a derivative instrument for accounting purposes and is accordingly carried at fair value. Excluded from the table above is the portion of the GLB derivative liability classified as Future policy benefits in the consolidated balance sheets. Refer to Note 5 for additional information.


16

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – continued (Unaudited)
ACE Limited and Subsidiaries


 
December 31, 2013
Level 1

 
Level 2

 
Level 3

 
Total

(in millions of U.S. dollars)
 
 
 
Assets:
 
 
 
 
 
 
 
Fixed maturities available for sale
 
 
 
 
 
 
 
U.S. Treasury and agency
$
1,626

 
$
1,323

 
$
—

 
$
2,949

Foreign
223

 
14,324

 
44

 
14,591

Corporate securities
—

 
17,304

 
166

 
17,470

Mortgage-backed securities
—

 
10,886

 
8

 
10,894

States, municipalities, and political subdivisions
—

 
3,350

 
—

 
3,350

 
1,849

 
47,187

 
218

 
49,254

Equity securities
373

 
460

 
4

 
837

Short-term investments
953

 
803

 
7

 
1,763

Other investments
305

 
231

 
2,440

 
2,976

Securities lending collateral
—

 
1,632

 
—

 
1,632

Investment derivative instruments
19

 
—

 
—

 
19

Other derivative instruments
—

 
6

 
—

 
6

Separate account assets
1,145

 
81

 
—

 
1,226

Total assets measured at fair value
$
4,644

 
$
50,400

 
$
2,669

 
$
57,713

Liabilities:
 
 
 
 
 
 
 
Investment derivative instruments
$
6

 
$
—

 
$
—

 
$
6

Other derivative instruments
60

 
2

 
—

 
62

GLB(1)
—

 
—

 
193

 
193

Total liabilities measured at fair value
$
66

 
$
2

 
$
193

 
$
261

(1) 
Our GLB reinsurance product meets the definition of a derivative instrument for accounting purposes and is accordingly carried at fair value. Excluded from the table above is the portion of the GLB derivative liability classified as Future policy benefits in the consolidated balance sheets. Refer to Note 5 for additional information.

The following table presents transfers of financial instruments between Level 1 and Level 2:
 
Three Months Ended
 
 
Six Months Ended
 
 
June 30
 
 
June 30
 
(in millions of U.S. dollars)
2014

 
2013

 
2014

 
2013

Transfers from Level 1 to Level 2
$
—

 
$
6

 
$
—

 
$
19

Transfers from Level 2 to Level 1
—

 
—

 
—

 
—


Fair value of alternative investments
Included in Other investments in the fair value hierarchy at June 30, 2014 and December 31, 2013 are investment funds, limited partnerships, and partially-owned investment companies measured at fair value using NAV as a practical expedient. At June 30, 2014 and December 31, 2013, there were no probable or pending sales related to any of the investments measured at fair value using NAV. 



17

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – continued (Unaudited)
ACE Limited and Subsidiaries


The following table presents, by investment category, the expected liquidation period, fair value, and maximum future funding commitments of alternative investments:
 
 
 
 
 
June 30

 
 
 
December 31

 
Expected
Liquidation
Period of Underlying Assets
 
 
 
2014

 
 
 
2013

(in millions of U.S. dollars)
Fair
Value

 
Maximum
Future Funding
Commitments

 
Fair
Value

 
Maximum
Future Funding
Commitments

Financial
5 to 9 Years
 
$
274

 
$
119

 
$
256

 
$
129

Real estate
3 to 9 Years
 
322

 
63

 
322

 
92

Distressed
6 to 9 Years
 
265

 
145

 
180

 
230

Mezzanine
6 to 9 Years
 
303

 
222

 
276

 
252

Traditional
3 to 8 Years
 
923

 
448

 
813

 
456

Vintage
1 to 3 Years
 
11

 
—

 
13

 
—

Investment funds
Not Applicable
 
385

 
—

 
428

 
—

 
 
 
$
2,483

 
$
997

 
$
2,288

 
$
1,159


Included in all categories in the above table except for Investment funds are investments for which ACE will never have the contractual option to redeem but receives distributions based on the liquidation of the underlying assets. Further, for all categories except for Investment funds, ACE does not have the ability to sell or transfer the investments without the consent from the general partner of individual funds.
Investment Category
 
Consists of investments in private equity funds:
Financial
 
targeting financial services companies such as financial institutions and insurance services worldwide
Real estate
 
targeting global distress opportunities, value added U.S. properties, and global mezzanine debt securities in the commercial real estate market
Distressed
 
targeting distressed debt/credit and equity opportunities in the U.S
Mezzanine
 
targeting private mezzanine debt of large-cap and mid-cap companies in the U.S. and worldwide
Traditional
 
employing traditional private equity investment strategies such as buyout and venture with different geographical focuses including Brazil, Asia, Europe, and the U.S.
Vintage
 
made before 2002 and where the funds’ commitment periods had already expired

Investment funds
ACE’s investment funds employ various investment strategies such as long/short equity and arbitrage/distressed. Included in this category are investments for which ACE has the option to redeem at agreed upon value as described in each investment fund’s subscription agreement. Depending on the terms of the various subscription agreements, investment fund investments may be redeemed monthly, quarterly, semi-annually, or annually. If ACE wishes to redeem an investment fund investment, it must first determine if the investment fund is still in a lock-up period (a time when ACE cannot redeem its investment so that the investment fund manager has time to build the portfolio). If the investment fund is no longer in its lock-up period, ACE must then notify the investment fund manager of its intention to redeem by the notification date prescribed by the subscription agreement. Subsequent to notification, the investment fund can redeem ACE’s investment within several months of the notification. Notice periods for redemption of the investment funds range between 5 and 120 days. ACE can redeem its investment funds without consent from the investment fund managers.

Level 3 financial instruments
The fair values of assets and liabilities measured at fair value using significant unobservable inputs (Level 3) consist of various inputs and assumptions that management makes when determining fair value. Management analyzes changes in fair value measurements classified within Level 3 by comparing pricing and returns of our investments to benchmarks, including month-over-month movements, investment credit spreads, interest rate movements, and credit quality of securities.



18

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – continued (Unaudited)
ACE Limited and Subsidiaries


The following table presents the significant unobservable inputs used in the Level 3 liability valuations. Excluded from the table below are inputs used to determine the fair value of Level 3 assets which are based on single broker quotes or net asset value and contain no quantitative unobservable inputs developed by management. 
(in millions of U.S. dollars, except for percentages)
Fair Value
 
Valuation
Technique
 
Significant
Unobservable Inputs
 
Ranges
June 30, 2014

 
December 31, 2013

 
 
 
GLB(1)
$
241

 
$
193

 
Actuarial model
 
Lapse rate
 
1% – 30%
 
 
 
 
 
 
 
Annuitization rate
 
0% – 55%
(1) 
Discussion of the most significant inputs used in the fair value measurement of GLB and the sensitivity of those assumptions is included within Note 4 a) Guaranteed living benefits.

The following tables present a reconciliation of the beginning and ending balances of financial instruments measured at fair value using significant unobservable inputs (Level 3): 
 
Assets
 
 
Liabilities

Three Months Ended
Available-for-Sale Debt Securities
Equity
securities

 
Other
investments

 
GLB(1)

June 30, 2014
Foreign

 
Corporate
securities

 
MBS

 
 
(in millions of U.S. dollars)
 
 
 
 
Balance–Beginning of Period
$
26

 
$
151

 
$
8

 
$
2

 
$
2,611

 
$
243

Transfers into Level 3
2

 
26

 
—

 
—

 
—

 
—

Transfers out of Level 3
(16
)
 
—

 
—

 
—

 
—

 
—

Change in Net Unrealized Gains (Losses) included in OCI
—

 
2

 
—

 
—

 
7

 
—

Net Realized Gains/Losses
1

 
—

 
—

 
—

 
(3
)
 
(2
)
Purchases
—

 
30

 
—

 
—

 
152

 
—

Sales
(1
)
 
(2
)
 
—

 
—

 
(2
)
 
—

Settlements
—

 
(3
)
 
(1
)
 
—

 
(125
)
 
—

Balance–End of Period
$
12

 
$
204

 
$
7

 
$
2

 
$
2,640

 
$
241

Net Realized Gains/Losses Attributable to Changes in Fair Value at the Balance Sheet Date
$
—

 
$
—

 
$
—

 
$
—

 
$
(3
)
 
$
(2
)
(1) 
Our GLB reinsurance product meets the definition of a derivative instrument for accounting purposes and is accordingly carried at fair value. Excluded from the table above is the portion of the GLB derivative liability classified as Future policy benefits in the consolidated balance sheets. Refer to Note 5 for additional information.


19

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – continued (Unaudited)
ACE Limited and Subsidiaries


  
Assets
 
 
Liabilities

 
Available-for-Sale Debt Securities
 
 
Equity
securities

 
Short-term investments

 
Other
investments

 
GLB(1)

Three Months Ended
Foreign

 
Corporate
securities

 
MBS

 
 
 
June 30, 2013
 
 
 
 
 
(in millions of U.S. dollars)
 
 
 
 
 
Balance–Beginning of Period
$
35

 
$
118

 
$
13

 
$
2

 
$
—

 
$
2,328

 
$
753

Transfers into Level 3
29

 
5

 
—

 
7

 
7

 
—

 
—

Transfers out of Level 3
(14
)
 
(27
)
 
—

 
—

 
—

 
—

 
—

Change in Net Unrealized Gains (Losses) included in OCI
(4
)
 
(1
)
 
—

 
(5
)
 
—

 
13

 
—

Net Realized Gains/Losses
—

 
(1
)
 
—

 
4

 
—

 
(1
)
 
(101
)
Purchases
3

 
23

 
—

 
1

 
2

 
113

 
—

Sales
(1
)
 
—

 
(3
)
 
(5
)
 
—

 
—

 
—

Settlements
—

 
(3
)
 
(1
)
 
—

 
—

 
(104
)
 
—

Balance–End of Period
$
48

 
$
114

 
$
9

 
$
4

 
$
9

 
$
2,349

 
$
652

Net Realized Gains/Losses Attributable to Changes in Fair Value at the Balance Sheet Date
$
—

 
$
—

 
$
—

 
$
—

 
$
—

 
$
(1
)
 
$
(101
)
(1) 
Our GLB reinsurance product meets the definition of a derivative instrument for accounting purposes and is accordingly carried at fair value. Excluded from the table above is the portion of the GLB derivative liability classified as Future policy benefits in the consolidated balance sheets. The liability for GLB reinsurance was $880 million at June 30, 2013, and $1.0 billion at March 31, 2013, which includes a fair value derivative adjustment of $652 million and $753 million, respectively.

 
Assets
 
 
Liabilities

Six Months Ended
Available-for-Sale Debt Securities
Equity
securities

 
Short-term investments

 
Other
investments

 
GLB(1)

June 30, 2014
Foreign

 
Corporate
securities

 
MBS

 
 
(in millions of U.S. dollars)
 
 
 
 
Balance–Beginning of Period
$
44

 
$
166

 
$
8

 
$
4

 
$
7

 
$
2,440

 
$
193

Transfers into Level 3
2

 
30

 
—

 
—

 
—

 
—

 
—

Transfers out of Level 3
(34
)
 
(22
)
 
—

 
(2
)
 
(7
)
 
—

 
—

Change in Net Unrealized Gains (Losses) included in OCI
(1
)
 
2

 
—

 
1

 
—

 
48

 
—

Net Realized Gains/Losses
1

 
—

 
—

 
—

 
—

 
(3
)
 
48

Purchases
2

 
45

 
—

 
1

 
—

 
352

 
—

Sales
(2
)
 
(8
)
 
—

 
(2
)
 
—

 
(3
)
 
—

Settlements
—

 
(9
)
 
(1
)
 
—

 
—

 
(194
)
 
—

Balance–End of Period
$
12

 
$
204

 
$
7

 
$
2

 
$
—

 
$
2,640

 
$
241

Net Realized Gains/Losses Attributable to Changes in Fair Value at the Balance Sheet Date
$
—

 
$
—

 
$
—

 
$
—

 
$
—

 
$
(3
)
 
$
48

(1) 
Our GLB reinsurance product meets the definition of a derivative instrument for accounting purposes and is accordingly carried at fair value. Excluded from the table above is the portion of the GLB derivative liability classified as Future policy benefits in the consolidated balance sheets. Refer to Note 5 for additional information.



20

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – continued (Unaudited)
ACE Limited and Subsidiaries


  
Assets
 
 
Liabilities

 
Available-for-Sale Debt Securities
 
 
Equity
securities

 
Short-term investments

Other
investments

 
GLB(1)

Six Months Ended
Foreign

 
Corporate
securities

 
MBS

 
 
 
June 30, 2013
 
 
 
 
 
(in millions of U.S. dollars)
 
 
 
 
 
Balance–Beginning of Period
$
60

 
$
102

 
$
13

 
$
3

 
$
—

$
2,252

 
$
1,119

Transfers into Level 3
32

 
17

 
—

 
7

 
7

—

 
—

Transfers out of Level 3
(41
)
 
(29
)
 
—

 
(1
)
 
—

—

 
—

Change in Net Unrealized Gains (Losses) included in OCI
(4
)
 
—

 
—

 
(5
)
 
—

35

 
—

Net Realized Gains/Losses
1

 
(1
)
 
—

 
4

 
—

(2
)
 
(467
)
Purchases
3

 
33

 
—

 
1

 
2

249

 
—

Sales
(2
)
 
—

 
(3
)
 
(5
)
 
—

(9
)
 
—

Settlements
(1
)
 
(8
)
 
(1
)
 
—

 
—

(176
)
 
—

Balance–End of Period
$
48

 
$
114

 
$
9

 
$
4

 
$
9

$
2,349

 
$
652

Net Realized Gains/Losses Attributable to Changes in Fair Value at the Balance Sheet Date
$
—

 
$
—

 
$
—

 
$
—

 
$
—

$
(2
)
 
$
(467
)
(1) 
Our GLB reinsurance product meets the definition of a derivative instrument for accounting purposes and is accordingly carried at fair value. Excluded from the table above is the portion of the GLB derivative liability classified as Future policy benefits in the consolidated balance sheets. The liability for GLB reinsurance was $880 million at June 30, 2013, and $1.4 billion at December 31, 2012, which includes a fair value derivative adjustment of $652 million and $1.1 billion, respectively.

b) Financial instruments disclosed, but not measured, at fair value
ACE uses various financial instruments in the normal course of its business. Our insurance contracts are excluded from fair value of financial instruments accounting guidance, and therefore, are not included in the amounts discussed below.

The carrying values of cash, other assets, other liabilities, and other financial instruments not included below approximated their fair values.

Investments in partially-owned insurance companies
Fair values for investments in partially-owned insurance companies are based on ACE’s share of the net assets based on the financial statements provided by those companies.

Short- and long-term debt and trust preferred securities
Where practical, fair values for short-term debt, long-term debt, and trust preferred securities are estimated using discounted cash flow calculations based principally on observable inputs including incremental borrowing rates, which reflect ACE’s credit rating, for similar types of borrowings with maturities consistent with those remaining for the debt being valued.



21

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – continued (Unaudited)
ACE Limited and Subsidiaries


The following tables present fair value, by valuation hierarchy, and carrying value of the financial instruments not measured at fair value:
June 30, 2014
Fair Value
 
 
Carrying Value

(in millions of U.S. dollars)
Level 1

 
Level 2

 
Level 3

 
Total

 
Assets:
 
 
 
 
 
 
 
 
 
Fixed maturities held to maturity
 
 
 
 
 
 
 
 
 
U.S. Treasury and agency
$
601

 
$
194

 
$
—

 
$
795

 
$
779

Foreign
—

 
853

 
—

 
853

 
809

Corporate securities
—

 
1,914

 
15

 
1,929

 
1,828

Mortgage-backed securities
—

 
1,241

 
—

 
1,241

 
1,187

States, municipalities, and political subdivisions
—

 
1,197

 
—

 
1,197

 
1,171

 
601

 
5,399

 
15

 
6,015

 
5,774

Partially-owned insurance companies
—

 
—

 
470

 
470

 
470

Total assets
$
601

 
$
5,399

 
$
485

 
$
6,485

 
$
6,244

Liabilities:
 
 
 
 
 
 
 
 
 
Short-term debt
$
—

 
$
1,870

 
$
—

 
$
1,870

 
$
1,851

Long-term debt
—

 
4,392

 
—

 
4,392

 
4,057

Trust preferred securities
—

 
456

 
—

 
456

 
309

Total liabilities
$
—

 
$
6,718

 
$
—

 
$
6,718

 
$
6,217


December 31, 2013
Fair Value
 
 
Carrying Value

(in millions of U.S. dollars)
Level 1

 
Level 2

 
Level 3

 
Total

 
Assets:
 
 
 
 
 
 
 
 
 
Fixed maturities held to maturity
 
 
 
 
 
 
 
 
 
U.S. Treasury and agency
$
596

 
$
236

 
$
—

 
$
832

 
$
820

Foreign
—

 
897

 
—

 
897

 
864

Corporate securities
—

 
1,990

 
15

 
2,005

 
1,922

Mortgage-backed securities
—

 
1,379

 
—

 
1,379

 
1,341

States, municipalities, and political subdivisions
—

 
1,150

 
—

 
1,150

 
1,151

 
596

 
5,652

 
15

 
6,263

 
6,098

Partially-owned insurance companies
—

 
—

 
470

 
470

 
470

Total assets
$
596

 
$
5,652

 
$
485

 
$
6,733

 
$
6,568

Liabilities:
 
 
 
 
 
 
 
 
 
Short-term debt
$
—

 
$
1,913

 
$
—

 
$
1,913

 
$
1,901

Long-term debt
—

 
4,088

 
—

 
4,088

 
3,807

Trust preferred securities
—

 
438

 
—

 
438

 
309

Total liabilities
$
—

 
$
6,439

 
$
—

 
$
6,439

 
$
6,017




22

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – continued (Unaudited)
ACE Limited and Subsidiaries



5. Assumed life reinsurance programs involving minimum benefit guarantees under annuity contracts

The following table presents income and expenses relating to GMDB and GLB reinsurance. GLBs include GMIBs as well as some GMABs originating in Japan.
 
Three Months Ended
 
 
Six Months Ended
 
 
June 30
 
 
June 30
 
(in millions of U.S. dollars)
2014

 
2013

 
2014

 
2013

GMDB
 
 
 
 
 
 
 
Net premiums earned
$
18

 
$
20

 
$
37

 
$
40

Policy benefits and other reserve adjustments
$
13

 
$
25

 
$
28

 
$
44

GLB
 
 
 
 
 
 
 
Net premiums earned
$
34

 
$
37

 
$
70

 
$
76

Policy benefits and other reserve adjustments
10

 
2

 
19

 
11

Net realized gains (losses)
2

 
101

 
(48
)
 
470

Gain recognized in income
$
26

 
$
136

 
$
3

 
$
535

Net cash received
$
29

 
$
31

 
$
62

 
$
63

Net (increase) decrease in liability
$
(3
)
 
$
105

 
$
(59
)
 
$
472


Net realized gains (losses) in the table above include gains (losses) related to foreign exchange and fair value adjustments on insurance derivatives and exclude gains (losses) on S&P put options and futures held to partially offset the risk in the GLB reinsurance portfolio. Refer to Note 7 for additional information.

At June 30, 2014, reported liabilities for GMDB and GLB reinsurance were $107 million and $486 million, respectively, compared with $100 million and $427 million, respectively, at December 31, 2013. The reported liability for GLB reinsurance of $486 million at June 30, 2014, and $427 million at December 31, 2013, includes a fair value derivative adjustment of $241 million and $193 million, respectively. Reported liabilities for both GMDB and GLB reinsurance are determined using internal valuation models. Such valuations require considerable judgment and are subject to significant uncertainty. The valuation of these products is subject to fluctuations arising from, among other factors, changes in interest rates, changes in equity markets, changes in credit markets, changes in the allocation of the investments underlying annuitants’ account values, and assumptions regarding future policyholder behavior. These models and the related assumptions are continually reviewed by management and enhanced, as appropriate, based upon improvements in modeling assumptions and availability of more information, such as market conditions and demographics of in-force annuities.

Variable Annuity Net Amount at Risk
(i) Reinsurance covering the GMDB risk only
At June 30, 2014 and December 31, 2013, the net amount at risk from reinsurance programs covering the GMDB risk only was $601 million and $586 million, respectively.

For reinsurance programs covering the GMDB risk only, the net amount at risk is defined as the present value of future claim payments under the following assumptions:

•
policy account values and guaranteed values are fixed at the valuation date (June 30, 2014 and December 31, 2013, respectively);
•
there are no lapses or withdrawals;
•
mortality according to 100 percent of the Annuity 2000 mortality table;
•
future claims are discounted in line with the discounting assumption used in the calculation of the benefit reserve averaging between 1.5 percent and 2.5 percent; and
•
reinsurance coverage ends at the earlier of the maturity of the underlying variable annuity policy or the reinsurance treaty.

The total claim amount payable on reinsurance programs covering the GMDB risk only, if all the cedants’ policyholders were to die immediately at June 30, 2014 was approximately $676 million. This takes into account all applicable reinsurance treaty claim limits.


23

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – continued (Unaudited)
ACE Limited and Subsidiaries



(ii) Reinsurance covering the GLB risk only
At June 30, 2014 and December 31, 2013, the net amount at risk from reinsurance programs covering the GLB risk only was $173 million and $136 million, respectively.

For reinsurance programs covering the GLB risk only, the net amount at risk is defined as the present value of future claim payments under the following assumptions:

•
policy account values and guaranteed values are fixed at the valuation date (June 30, 2014 and December 31, 2013, respectively);
•
there are no deaths, lapses, or withdrawals;
•
policyholders annuitize at a frequency most disadvantageous to ACE (in other words, annuitization at a level that maximizes claims taking into account the treaty limits) under the terms of the reinsurance contracts;
•
for annuitizing policyholders, the GMIB claim is calculated using interest rates in line with those used in calculating the reserve;
•
future claims are discounted in line with the discounting assumption used in the calculation of the benefit reserve averaging between 3.5 percent and 4.5 percent; and
•
reinsurance coverage ends at the earlier of the maturity of the underlying variable annuity policy or the reinsurance treaty. 

(iii) Reinsurance covering both the GMDB and GLB risks on the same underlying policyholders
At June 30, 2014 and December 31, 2013, the GMDB net amount at risk from reinsurance programs covering both the GMDB and GLB risks on the same underlying policyholders was $69 million and $73 million, respectively.

At June 30, 2014 and December 31, 2013, the GLB net amount at risk from reinsurance programs covering both the GMDB and GLB risks on the same underlying policyholders was $142 million and $141 million, respectively.

These net amounts at risk reflect the interaction between the two types of benefits on any single policyholder (eliminating double-counting), and therefore the net amounts at risk should be considered additive.

For reinsurance programs covering both the GMDB and GLB risks on the same underlying policyholders, the net amount at risk is defined as the present value of future claim payments under the following assumptions:

•
policy account values and guaranteed values are fixed at the valuation date (June 30, 2014 and December 31, 2013, respectively);
•
there are no lapses or withdrawals;
•
mortality according to 100 percent of the Annuity 2000 mortality table;
•
policyholders annuitize at a frequency most disadvantageous to ACE (in other words, annuitization at a level that maximizes claims taking into account the treaty limits) under the terms of the reinsurance contracts;
•
for annuitizing policyholders, the GMIB claim is calculated using interest rates in line with those used in calculating the reserve;
•
future claims are discounted in line with the discounting assumption used in the calculation of the benefit reserve averaging between 3.0 percent and 4.0 percent; and
•
reinsurance coverage ends at the earlier of the maturity of the underlying variable annuity policy or the reinsurance treaty.

The total claim amount payable on reinsurance programs covering both the GMDB and GLB risks on the same underlying policyholders, if all of the cedants’ policyholders were to die immediately at June 30, 2014 was approximately $64 million. This takes into account all applicable reinsurance treaty claim limits. Although there would be an increase in death claims resulting from 100 percent immediate mortality of all policyholders, the GLB claims would be zero.

The average attained age of all policyholders under sections i), ii), and iii) above, weighted by the guaranteed value of each reinsured policy, is approximately 69 years.

6. Debt

In May 2014, ACE INA Holdings Inc. issued $700 million of 3.35 percent senior notes due May 2024.  These senior notes are redeemable at any time at ACE INA Holdings Inc.'s option subject to a “make-whole” premium (the present value of the remaining principal and interest discounted at the applicable U.S. Treasury rate plus 0.15 percent). The notes are also


24

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – continued (Unaudited)
ACE Limited and Subsidiaries


redeemable at par plus accrued and unpaid interest in the event of certain changes in tax law. These notes do not have the benefit of any sinking fund.  These senior unsecured notes are guaranteed on a senior basis by ACE Limited and they rank equally with all of ACE's other senior obligations.  They also contain customary limitations on lien provisions as well as customary events of default provisions which, if breached, could result in the accelerated maturity of such senior debt.

In May 2014, we reclassified ACE INA Holdings Inc.'s $450 million of 5.6 percent senior notes, due to mature on May 15, 2015, from Long-term debt to Short-term debt in the consolidated balance sheet.

In June 2014, ACE INA Holdings Inc.'s $500 million of 5.875 percent senior notes matured and were fully paid.

7. Commitments, contingencies, and guarantees

a) Derivative instruments
Derivative instruments employed
ACE maintains positions in derivative instruments such as futures, options, swaps, and foreign currency forward contracts for which the primary purposes are to manage duration and foreign currency exposure, yield enhancement, or to obtain an exposure to a particular financial market. ACE also maintains positions in convertible securities that contain embedded derivatives. Investment derivative instruments are recorded in either Other assets (OA) or Accounts payable, accrued expenses, and other liabilities (AP), convertible bonds are recorded in Fixed maturities available for sale (FM AFS) and convertible equity securities are recorded in Equity securities (ES) in the consolidated balance sheets. These are the most numerous and frequent derivative transactions.

In addition, ACE from time to time purchases to be announced mortgage-backed securities (TBAs) as part of its investing activities.

Under reinsurance programs covering GLBs, ACE assumes the risk of GLBs, including GMIB and GMAB, associated with variable annuity contracts. The GMIB risk is triggered if, at the time the contract holder elects to convert the accumulated account value to a periodic payment stream (annuitize), the accumulated account value is not sufficient to provide a guaranteed minimum level of monthly income. The GMAB risk is triggered if, at contract maturity, the contract holder’s account value is less than a guaranteed minimum value. The GLB reinsurance product meets the definition of a derivative instrument. Benefit reserves in respect of GLBs are classified as Future policy benefits (FPB) while the fair value derivative adjustment is classified within AP. ACE also maintains positions in exchange-traded equity futures contracts and options on equity market indices to limit equity exposure in the GMDB and GLB blocks of business.

In relation to certain debt issuances, ACE from time to time enters into interest rate swap transactions for the purpose of either fixing or reducing borrowing costs. Although the use of these interest rate swaps has the economic effect of fixing or reducing borrowing costs on a net basis, gross interest expense on the related debt issuances is included in Interest expense while the settlements related to the interest rate swaps are reflected in Net realized gains (losses) in the consolidated statements of operations. At June 30, 2014, ACE had no in-force interest rate swaps.

All derivative instruments are carried at fair value with changes in fair value recorded in Net realized gains (losses) in the consolidated statements of operations. None of the derivative instruments are designated as hedges for accounting purposes.



25

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – continued (Unaudited)
ACE Limited and Subsidiaries


The following table presents the balance sheet locations, fair values of derivative instruments in an asset or (liability) position, and notional values/payment provisions of our derivative instruments:
 
 
 
 
 
June 30, 2014
 
 
 
 
December 31, 2013
 
 
Consolidated
Balance Sheet
Location
 
Fair Value
 
 
Notional
Value/
Payment
Provision

 
Fair Value
 
 
Notional
Value/
Payment
Provision

(in millions of U.S. dollars)
 
Derivative Asset

 
Derivative (Liability)

 
 
Derivative Asset

 
Derivative (Liability)

 
Investment and embedded derivative instruments
 
 
 
 
 
 
 
 
 
 
 
 
 
Foreign currency forward contracts
OA / (AP)
 
$
2

 
$
(4
)
 
$
1,296

 
$
3

 
$
(4
)
 
$
1,202

Cross-currency swaps
OA / (AP)
 
—

 
—

 
95

 
—

 
—

 
50

Options/Futures contracts on money market instruments
OA / (AP)
 
2

 
—

 
1,432

 
3

 
—

 
3,910

Futures contracts on notes and bonds
OA / (AP)
 
5

 
(6
)
 
1,372

 
13

 
(2
)
 
871

Convertible securities(1)
FM AFS / ES
 
333

 
—

 
280

 
302

 
—

 
254

 
 
 
$
342

 
$
(10
)
 
$
4,475

 
$
321

 
$
(6
)
 
$
6,287

Other derivative instruments
 
 
 
 
 
 
 
 
 
 
 
 
 
Futures contracts on equities (2)
OA / (AP)
 
$
—

 
$
(15
)
 
$
1,468

 
$
—

 
$
(60
)
 
$
1,692

Options on equity market indices (2)
OA / (AP)
 
2

 
—

 
250

 
6

 
—

 
250

Other
OA / (AP)
 
16

 
(2
)
 
72

 
—

 
(2
)
 
8

 
 
 
$
18

 
$
(17
)
 
$
1,790

 
$
6

 
$
(62
)
 
$
1,950

GLB(3)
(AP) / (FPB)
 
$
—

 
$
(486
)
 
$
315

 
$
—

 
$
(427
)
 
$
277

(1) 
Includes fair value of embedded derivatives.
(2) 
Related to GMDB and GLB blocks of business.
(3) 
Includes both future policy benefits reserves and fair value derivative adjustment. Refer to Note 5 for additional information. Note that the payment provision related to GLB is the net amount at risk. The concept of a notional value does not apply to the GLB reinsurance contracts.

At June 30, 2014 and December 31, 2013, derivative liabilities of $14 million and $41 million, respectively, included in the table above were subject to a master netting agreement.  The remaining derivatives included in the table above were not subject to a master netting agreement. 

At both June 30, 2014 and December 31, 2013, our repurchase obligations of $1,401 million were fully collateralized.  At June 30, 2014 and December 31, 2013, our securities lending payable was $1,441 million and $1,633 million, respectively, and our securities lending collateral was $1,440 million and $1,632 million, respectively.  The securities lending collateral can only be accessed in the event that the institution borrowing the securities is in default under the lending agreement.  An indemnification agreement with the lending agent protects us in the event a borrower becomes insolvent or fails to return any of the securities on loan.  In contrast to securities lending programs, the use of cash received is not restricted for the repurchase obligations.



26

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – continued (Unaudited)
ACE Limited and Subsidiaries


The following table presents net realized gains (losses) related to derivative instrument activity in the consolidated statements of operations:
 
Three Months Ended
 
 
Six Months Ended
 
 
June 30
 
 
June 30
 
(in millions of U.S. dollars)
2014

 
2013

 
2014

 
2013

Investment and embedded derivative instruments
 
 
 
 
 
 
 
Foreign currency forward contracts
$
(1
)
 
$
12

 
$
(4
)
 
$
17

All other futures contracts and options
(18
)
 
33

 
(40
)
 
40

Convertible securities(1)
4

 
(5
)
 
4

 
1

Total investment and embedded derivative instruments
$
(15
)
 
$
40

 
$
(40
)
 
$
58

GLB and other derivative instruments
 
 
 
 
 
 
 
GLB(2)
$
2

 
$
101

 
$
(46
)
 
$
429

Futures contracts on equities(3)
(71
)
 
(66
)
 
(88
)
 
(303
)
Options on equity market indices(3)
(1
)
 
(2
)
 
(3
)
 
(15
)
Other
9

 
(1
)
 
7

 
(1
)
Total GLB and other derivative instruments
$
(61
)
 
$
32

 
$
(130
)
 
$
110

 
$
(76
)
 
$
72

 
$
(170
)
 
$
168

(1) 
Includes embedded derivatives.
(2) 
Excludes foreign exchange gains (losses) related to GLB.
(3) 
Related to GMDB and GLB blocks of business.

Derivative instrument objectives

(i) Foreign currency exposure management
A foreign currency forward contract (forward) is an agreement between participants to exchange specific foreign currencies at a future date. ACE uses forwards to minimize the effect of fluctuating foreign currencies.

(ii) Duration management and market exposure
Futures
Futures contracts give the holder the right and obligation to participate in market movements, determined by the index or underlying security on which the futures contract is based. Settlement is made daily in cash by an amount equal to the change in value of the futures contract times a multiplier that scales the size of the contract. Exchange-traded futures contracts on money market instruments, notes and bonds are used in fixed maturity portfolios to more efficiently manage duration, as substitutes for ownership of the money market instruments, bonds and notes without significantly increasing the risk in the portfolio. Investments in futures contracts may be made only to the extent that there are assets under management not otherwise committed.

Exchange-traded equity futures contracts are used to limit exposure to a severe equity market decline, which would cause an increase in expected claims and therefore, reserves for GMDB and GLB reinsurance business.

Options
An option contract conveys to the holder the right, but not the obligation, to purchase or sell a specified amount or value of an underlying security at a fixed price. Option contracts are used in the investment portfolio as protection against unexpected shifts in interest rates, which would affect the duration of the fixed maturity portfolio. By using options in the portfolio, the overall interest rate sensitivity of the portfolio can be reduced. Option contracts may also be used as an alternative to futures contracts in the synthetic strategy as described above.

Another use for option contracts is to limit exposure to a severe equity market decline, which would cause an increase in expected claims and therefore, reserves for GMDB and GLB reinsurance business.

The price of an option is influenced by the underlying security, expected volatility, time to expiration, and supply and demand.

The credit risk associated with the above derivative financial instruments relates to the potential for non-performance by counterparties. Although non-performance is not anticipated, in order to minimize the risk of loss, management monitors the


27

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – continued (Unaudited)
ACE Limited and Subsidiaries


creditworthiness of its counterparties and obtains collateral. The performance of exchange-traded instruments is guaranteed by the exchange on which they trade. For non-exchange-traded instruments, the counterparties are principally banks which must meet certain criteria according to our investment guidelines.

Cross-currency swaps
Cross-currency swaps are agreements under which two counterparties exchange interest payments and principal denominated in different currencies at a future date.  We use cross-currency swaps to reduce the foreign currency and interest rate risk by converting cash flows back into local currency.  We invest in foreign currency denominated investments to improve credit diversification and also to obtain better duration matching to our liabilities that is limited in the local currency market.

Other
Included within Other are derivatives intended to reduce potential losses which may arise from certain exposures in our insurance business.  The economic benefit provided by these derivatives is similar to purchased reinsurance.  For example, from time to time ACE may enter into crop derivative contracts to protect underwriting results in the event of a significant decline in commodity prices.  Also included within Other are certain life insurance products that meet the definition of a derivative instrument for accounting purposes. 

(iii) Convertible security investments
A convertible security is a debt instrument or preferred stock that can be converted into a predetermined amount of the issuer’s equity. The convertible option is an embedded derivative within the host instruments which are classified in the investment portfolio as either available for sale or as an equity security. ACE purchases convertible securities for their total return and not specifically for the conversion feature.

(iv) TBA
By acquiring TBAs, we make a commitment to purchase a future issuance of mortgage-backed securities. For the period between purchase of the TBAs and issuance of the underlying security, we account for our position as a derivative in the consolidated financial statements. ACE purchases TBAs both for their total return and for the flexibility they provide related to our mortgage-backed security strategy.

(v) GLB
Under the GLB program, as the assuming entity, ACE is obligated to provide coverage until the expiration or maturity of the underlying deferred annuity contracts or the expiry of the reinsurance treaty. Premiums received under the reinsurance treaties are classified as premium. Expected losses allocated to premiums received are classified as Future policy benefits and valued similar to GMDB reinsurance. Other changes in fair value, principally arising from changes in expected losses allocated to expected future premiums, are classified as Net realized gains (losses). Fair value represents management’s estimate of exit price and thus, includes a risk margin. We may recognize a realized loss for other changes in fair value due to adverse changes in the capital markets (e.g., declining interest rates and/or declining equity markets) and changes in actual or estimated future policyholder behavior (e.g., increased annuitization or decreased lapse rates) although we expect the business to be profitable. We believe this presentation provides the most meaningful disclosure of changes in the underlying risk within the GLB reinsurance programs for a given reporting period.

b) Other investments
At June 30, 2014, included in Other investments in the consolidated balance sheet are investments in limited partnerships and partially-owned investment companies with a carrying value of $2.1 billion. In connection with these investments, we have commitments that may require funding of up to $1.0 billion over the next several years. 

c) Taxation
As of June 30, 2014, $27 million of unrecognized tax benefits remains outstanding. It is reasonably possible that over the next twelve months, the amount of unrecognized tax benefits may change resulting from the re-evaluation of unrecognized tax benefits arising from examinations of taxing authorities. With few exceptions, ACE is no longer subject to state and local or non-U.S. income tax examinations for years before 2005.

d) Letters of credit
We did not renew our $500 million bilateral letter of credit facility that expired in June 2014.  We elected instead to satisfy our collateral obligations primarily with insurance trusts supported by our investment portfolio.



28

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – continued (Unaudited)
ACE Limited and Subsidiaries


e) Legal proceedings
Our insurance subsidiaries are subject to claims litigation involving disputed interpretations of policy coverages and, in some jurisdictions, direct actions by allegedly-injured persons seeking damages from policyholders. These lawsuits, involving claims on policies issued by our subsidiaries which are typical to the insurance industry in general and in the normal course of business, are considered in our loss and loss expense reserves. In addition to claims litigation, we are subject to lawsuits and regulatory actions in the normal course of business that do not arise from or directly relate to claims on insurance policies. This category of business litigation typically involves, among other things, allegations of underwriting errors or misconduct, employment claims, regulatory activity, or disputes arising from our business ventures. In the opinion of management, our ultimate liability for these matters could be, but we believe is not likely to be, material to our consolidated financial condition and results of operations.

8. Shareholders’ equity

All of ACE’s Common Shares are authorized under Swiss corporate law. Though the par value of Common Shares is stated in Swiss francs, ACE continues to use U.S. dollars as its reporting currency for preparing consolidated financial statements. Under Swiss corporate law, dividends, including distributions through a reduction in par value (par value reduction) or from legal reserves, must be stated in Swiss francs though dividend payments are made by ACE in U.S. dollars. At our May 2013 and May 2014 annual general meetings, our shareholders approved a dividend for the following year, respectively, payable in four quarterly installments after the annual general meetings in the form of a distribution by way of a par value reduction. At the January 10, 2014 Extraordinary General Meeting, our shareholders approved a resolution to increase our quarterly dividend from $0.51 per share to $0.63 per share for the final two quarterly installments (made on January 31, 2014 and April 17, 2014) that had been earlier approved at our 2013 annual general meeting. The $0.12 per share increase for each installment was distributed from capital contribution reserves (Additional paid-in capital), a subaccount of legal reserves, and transferred to free reserves (Retained earnings) for payment, while the existing $0.51 per share was distributed by way of a par value reduction.

For the three and six months ended June 30, 2014, dividends per Common Share amounted to CHF 0.58 ($0.65) and CHF 1.23 ($1.40), respectively. For the six months ended June 30, 2014, dividends included a distribution from capital contribution reserves of CHF 0.20 ($0.24). Par value reductions have been reflected as such through Common Shares in the consolidated statements of shareholders' equity and had the effect of reducing par value per Common Share to CHF 26.01 at June 30, 2014.

For the three and six months ended June 30, 2013, dividends per Common Share amounted to CHF 0.48 ($0.51) and CHF 0.94 ($1.00).

Common Shares in treasury are used principally for issuance upon the exercise of employee stock options, grants of restricted stock, and purchases under the Employee Stock Purchase Plan (ESPP). At June 30, 2014, 6,606,823 Common Shares remain in treasury after net shares redeemed under employee share-based compensation plans.

ACE Limited securities repurchase authorization
For the three and six months ended June 30, 2014, ACE repurchased 2,306,000 and 5,793,882 Common Shares for a cost of $237 million and $569 million, respectively, in a series of open market transactions under the November 2013 Board authorization of a share repurchase program of up to $2.0 billion of ACE's Common Shares through December 31, 2014. At June 30, 2014, $1.37 billion in share repurchase authorization remained through December 31, 2014 pursuant to the Board authorization. For the period July 1, 2014 through July 29, 2014, ACE repurchased 1,281,630 Common Shares for a total of $133 million in a series of open market transactions. At July 29, 2014, $1.24 billion in share repurchase authorization remained through December 31, 2014.

9. Share-based compensation

The ACE Limited 2004 Long-Term Incentive Plan (the 2004 LTIP) permits grants of both incentive and non-qualified stock options principally at an option price per share equal to the grant date fair value of ACE’s Common Shares. Stock options are generally granted with a 3-year vesting period and a 10-year term. Stock options typically vest in equal annual installments over the vesting period, which is also the requisite service period. On February 27, 2014, ACE granted 1,779,074 stock options with a weighted-average grant date fair value of $18.00 each. The fair value of the options issued is estimated on the date of grant using the Black-Scholes option pricing model.



29

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – continued (Unaudited)
ACE Limited and Subsidiaries


The 2004 LTIP also permits grants of restricted stock and restricted stock units. ACE generally grants restricted stock and restricted stock units with a 4-year vesting period, based on a graded vesting schedule. The restricted stock is granted at market close price on the grant date. On February 27, 2014, ACE granted 1,492,290 restricted stock awards and 276,992 restricted stock units to employees and officers with a grant date fair value of $96.76 each. Each restricted stock unit represents our obligation to deliver to the holder one Common Share upon vesting.

10. Segment information

ACE operates through five business segments: Insurance – North American P&C, Insurance – North American Agriculture, Insurance – Overseas General, Global Reinsurance, and Life. These segments distribute their products through various forms of brokers, agencies, and direct marketing programs. All business segments have established relationships with reinsurance intermediaries.

For segment reporting purposes, certain items have been presented in a different manner below than in the consolidated financial statements. Management uses underwriting income as the main measure of segment performance. ACE calculates underwriting income by subtracting Losses and loss expenses, Policy benefits, Policy acquisition costs, and Administrative expenses from Net premiums earned. For the Insurance – North American Agriculture segment, management includes gains and losses from fair value changes on crop derivatives as a component of underwriting income. For example, for the three months ended June 30, 2014, underwriting income in our Insurance – North American Agriculture segment was $27 million. This amount includes $8 million of realized gains related to crop derivatives which are included in Net realized gains (losses) below. For the Life segment, management includes Net investment income and (Gains) losses from fair value changes in separate account assets that do not qualify for separate account reporting under GAAP as components of Life underwriting income. For example, for the three months ended June 30, 2014, Life underwriting income of $89 million includes Net investment income of $66 million and gains from fair value changes in separate account assets of $17 million.

The following tables present the Statement of Operations by segment:
For the Three Months Ended June 30, 2014
Insurance – North American P&C

 
Insurance – North American Agriculture

 
Insurance –
Overseas
General

 
Global
Reinsurance

 
Life

 
Corporate

 
ACE
Consolidated

(in millions of U.S. dollars)
 
 
 
 
 
Net premiums written
$
1,635

 
$
388

 
$
1,760

 
$
278

 
$
498

 
$
—

 
$
4,559

Net premiums earned
1,542

 
330

 
1,709

 
261

 
490

 
—

 
4,332

Losses and loss expenses
1,016

 
287

 
830

 
109

 
146

 
—

 
2,388

Policy benefits
—

 
—

 
—

 
—

 
144

 
—

 
144

Policy acquisition costs
152

 
23

 
402

 
60

 
121

 
—

 
758

Administrative expenses
175

 
1

 
256

 
14

 
73

 
47

 
566

Underwriting income (loss)
199

 
19

 
221

 
78

 
6

 
(47
)
 
476

Net investment income
265

 
6

 
136

 
80

 
66

 
3

 
556

Net realized gains (losses) including OTTI
(11
)
 
8

 
14

 
(15
)
 
(72
)
 
3

 
(73
)
Interest expense
2

 
—

 
1

 
2

 
3

 
64

 
72

Other (income) expense:
 
 
 
 
 
 
 
 
 
 
 
 
 
(Gains) losses from fair value changes in separate account assets
—

 
—

 
—

 
—

 
(17
)
 
—

 
(17
)
Other
(24
)
 
9

 
8

 
(10
)
 
4

 
5

 
(8
)
Income tax expense (benefit)
91

 
5

 
55

 
10

 
12

 
(40
)
 
133

Net income (loss)
$
384

 
$
19

 
$
307

 
$
141

 
$
(2
)
 
$
(70
)
 
$
779



30

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – continued (Unaudited)
ACE Limited and Subsidiaries


For the Three Months Ended June 30, 2013
Insurance – North American P&C

 
Insurance – North American Agriculture

 
Insurance –
Overseas
General

 
Global
Reinsurance

 
Life

 
Corporate

 
ACE
Consolidated

(in millions of U.S. dollars)
 
 
 
 
 
 
Net premiums written
$
1,529

 
$
453

 
$
1,630

 
$
292

 
$
487

 
$
—

 
$
4,391

Net premiums earned
1,428

 
351

 
1,563

 
245

 
480

 
—

 
4,067

Losses and loss expenses
950

 
293

 
768

 
93

 
145

 
1

 
2,250

Policy benefits
—

 
—

 
—

 
—

 
110

 
—

 
110

Policy acquisition costs
142

 
20

 
360

 
48

 
95

 
—

 
665

Administrative expenses
159

 
3

 
251

 
12

 
86

 
53

 
564

Underwriting income (loss)
177

 
35

 
184

 
92

 
44

 
(54
)
 
478

Net investment income
250

 
7

 
136

 
71

 
63

 
7

 
534

Net realized gains (losses) including OTTI
28

 
1

 
8

 
31

 
36

 
—

 
104

Interest expense
3

 
—

 
2

 
1

 
4

 
63

 
73

Other (income) expense:
 
 
 
 
 
 
 
 
 
 
 
 
 
(Gains) losses from fair value changes in separate account assets
—

 
—

 
—

 
—

 
11

 
—

 
11

Other
(10
)
 
8

 
17

 
2

 
3

 
6

 
26

Income tax expense (benefit)
91

 
8

 
50

 
7

 
10

 
(51
)
 
115

Net income (loss)
$
371

 
$
27

 
$
259

 
$
184

 
$
115

 
$
(65
)
 
$
891


For the Six Months Ended June 30, 2014
Insurance – North American P&C

 
Insurance – North American Agriculture

 
Insurance –
Overseas
General

 
Global
Reinsurance

 
Life

 
Corporate

 
ACE
Consolidated

(in millions of U.S. dollars)
 
 
 
 
 
 
Net premiums written
$
3,053

 
$
582

 
$
3,531

 
$
586

 
$
992

 
$
—

 
$
8,744

Net premiums earned
3,029

 
433

 
3,321

 
545

 
974

 
—

 
8,302

Losses and loss expenses
1,956

 
413

 
1,647

 
235

 
297

 
1

 
4,549

Policy benefits
—

 
—

 
—

 
—

 
258

 
—

 
258

Policy acquisition costs
311

 
28

 
788

 
127

 
232

 
—

 
1,486

Administrative expenses
336

 
2

 
506

 
28

 
141

 
88

 
1,101

Underwriting income (loss)
426

 
(10
)
 
380

 
155

 
46

 
(89
)
 
908

Net investment income
535

 
13

 
268

 
157

 
130

 
6

 
1,109

Net realized gains (losses) including OTTI
(20
)
 
6

 
4

 
(23
)
 
(148
)
 
4

 
(177
)
Interest expense
5

 
—

 
2

 
3

 
6

 
127

 
143

Other (income) expense:
 
 
 
 
 
 
 
 
 
 
 
 
 
(Gains) losses from fair value changes in separate account assets
—

 
—

 
—

 
—

 
(11
)
 
—

 
(11
)
Other
(44
)
 
17

 
2

 
(29
)
 
11

 
12

 
(31
)
Income tax expense (benefit)
174

 
(2
)
 
92

 
20

 
22

 
(80
)
 
226

Net income (loss)
$
806

 
$
(6
)
 
$
556

 
$
295

 
$
—

 
$
(138
)
 
$
1,513




31

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – continued (Unaudited)
ACE Limited and Subsidiaries


For the Six Months Ended June 30, 2013
Insurance – North American P&C

 
Insurance – North American Agriculture

 
Insurance –
Overseas
General

 
Global
Reinsurance

 
Life

 
Corporate

 
ACE
Consolidated

(in millions of U.S. dollars)
 
 
 
 
 
 
Net premiums written
$
2,813

 
$
566

 
$
3,250

 
$
571

 
$
989

 
$
—

 
$
8,189

Net premiums earned
2,766

 
403

 
3,022

 
492

 
957

 
—

 
7,640

Losses and loss expenses
1,828

 
325

 
1,515

 
199

 
302

 
7

 
4,176

Policy benefits
—

 
—

 
—

 
—

 
241

 
—

 
241

Policy acquisition costs
285

 
24

 
699

 
96

 
175

 
—

 
1,279

Administrative expenses
284

 
8

 
487

 
24

 
171

 
104

 
1,078

Underwriting income (loss)
369

 
46

 
321

 
173

 
68

 
(111
)
 
866

Net investment income
501

 
13

 
268

 
143

 
126

 
14

 
1,065

Net realized gains (losses) including OTTI
54

 
1

 
42

 
51

 
163

 
(1
)
 
310

Interest expense
1

 
—

 
3

 
2

 
8

 
119

 
133

Other (income) expense:
 
 
 
 
 
 
 
 
 
 
 
 
 
(Gains) losses from fair value changes in separate account assets
—

 
—

 
—

 
—

 
7

 
—

 
7

Other
(25
)
 
16

 
16

 
(6
)
 
3

 
16

 
20

Income tax expense (benefit)
185

 
10

 
96

 
15

 
23

 
(92
)
 
237

Net income (loss)
$
763

 
$
34

 
$
516

 
$
356

 
$
316

 
$
(141
)
 
$
1,844


Underwriting assets are reviewed in total by management for purposes of decision-making. Other than goodwill and other intangible assets, ACE does not allocate assets to its segments.



32

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – continued (Unaudited)
ACE Limited and Subsidiaries


The following table presents net premiums earned for each segment by product:
(in millions of U.S. dollars)
Property &
All Other

 
Casualty

 
Life,
Accident &
Health

 
ACE
Consolidated

For the Three Months Ended June 30, 2014
 
 
 
Insurance – North American P&C
$
423

 
$
1,018

 
$
101

 
$
1,542

Insurance – North American Agriculture
330

 
—

 
—

 
330

Insurance – Overseas General
727

 
395

 
587

 
1,709

Global Reinsurance
132

 
129

 
—

 
261

Life
—

 
—

 
490

 
490

 
$
1,612

 
$
1,542

 
$
1,178

 
$
4,332

For the Three Months Ended June 30, 2013
 
 
 
 
 
 
 
Insurance – North American P&C
$
368

 
$
967

 
$
93

 
$
1,428

Insurance – North American Agriculture
351

 
—

 
—

 
351

Insurance – Overseas General
658

 
374

 
531

 
1,563

Global Reinsurance
132

 
113

 
—

 
245

Life
—

 
—

 
480

 
480

 
$
1,509

 
$
1,454

 
$
1,104

 
$
4,067

 
 
 
 
 
 
 
 
(in millions of U.S. dollars)
Property &
All Other

 
Casualty

 
Life,
Accident &
Health

 
ACE
Consolidated

For the Six Months Ended June 30, 2014
 
 
 
Insurance – North American P&C
$
828

 
$
1,999

 
$
202

 
$
3,029

Insurance – North American Agriculture
433

 
—

 
—

 
433

Insurance – Overseas General
1,420

 
764

 
1,137

 
3,321

Global Reinsurance
286

 
259

 
—

 
545

Life
—

 
—

 
974

 
974

 
$
2,967

 
$
3,022

 
$
2,313

 
$
8,302

For the Six Months Ended June 30, 2013
 
 
 
 
 
 
 
Insurance – North American P&C
$
715

 
$
1,869

 
$
182

 
$
2,766

Insurance – North American Agriculture
403

 
—

 
—

 
403

Insurance – Overseas General
1,243

 
713

 
1,066

 
3,022

Global Reinsurance
267

 
225

 
—

 
492

Life
—

 
—

 
957

 
957

 
$
2,628

 
$
2,807

 
$
2,205

 
$
7,640




33

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – continued (Unaudited)
ACE Limited and Subsidiaries


11. Earnings per share

 
Three Months Ended
 
 
Six Months Ended
 
 
June 30
 
 
June 30
 
(in millions of U.S. dollars, except share and per share data)
2014

 
2013

 
2014

 
2013

Numerator:
 
 
 
 
 
 
 
Net income
$
779

 
$
891

 
$
1,513

 
$
1,844

Denominator:
 
 
 
 
 
 
 
Denominator for basic earnings per share:
 
 
 
 
 
 
 
Weighted-average shares outstanding
337,846,228

 
341,047,290

 
338,353,260

 
340,913,450

Denominator for diluted earnings per share:
 
 
 
 

 

Share-based compensation plans
3,286,359

 
3,053,975

 
3,267,499

 
3,120,263

Weighted-average shares outstanding and assumed conversions
341,132,587

 
344,101,265

 
341,620,759

 
344,033,713

Basic earnings per share
$
2.30

 
$
2.61

 
$
4.47

 
$
5.41

Diluted earnings per share
$
2.28

 
$
2.59

 
$
4.43

 
$
5.36

 
 
 
 
 
 
 
 
Potential anti-dilutive share conversions
1,778,040

 
1,811,030

 
1,220,731

 
1,231,105


Excluded from weighted-average shares outstanding and assumed conversions is the impact of securities that would have been anti-dilutive during the respective periods.

12. Information provided in connection with outstanding debt of subsidiaries

The following tables present condensed consolidating financial information at June 30, 2014 and December 31, 2013, and for the three and six months ended June 30, 2014 and 2013 for ACE Limited (Parent Guarantor) and ACE INA Holdings Inc. (Subsidiary Issuer). The Subsidiary Issuer is an indirect 100 percent-owned subsidiary of the Parent Guarantor. The Parent Guarantor fully and unconditionally guarantees certain of the debt of the Subsidiary Issuer.
 
During the third quarter of 2013, we determined that the Subsidiary Issuer columns presented in the previously issued condensed consolidating financial information should be presented on the equity method of accounting rather than on a consolidated basis. Accordingly, we have revised the disclosure to correct the Condensed Consolidating Statement of Operations and Comprehensive Income for the three and six months ended June 30, 2013 and the Condensed Consolidating Statement of Cash Flows for the six months ended June 30, 2013. As a result of this revision to the Subsidiary Issuer condensed consolidating financial information, revenues and expenses and cash flows of the subsidiaries of ACE INA Holdings Inc. (Subsidiary Issuer) are now presented in the Other ACE Limited Subsidiaries column on a combined basis. In addition, we revised the Consolidating Adjustments and Eliminations column to correctly include all intercompany eliminations. Previously, this column reflected only ACE Limited parent company intercompany eliminations. We also revised the Condensed Consolidating Statement of Cash Flows for the six months ended June 30, 2013 to correct the presentation of negative cash associated with our affiliated notional cash pooling programs (Pools). In addition, certain items in the Condensed Consolidating Statement of Cash Flows for the six months ended June 30, 2013 have been reclassified to conform to current period presentation. Also, the operating cash flows have been corrected to properly reflect certain intercompany transactions previously recorded in financing cash flows for the six months ended June 30, 2013.

Total shareholders' equity and net income of the Subsidiary Issuer and Parent Guarantor were not impacted as a result of these revisions. The impact of the revisions was not material to the prior period consolidated financial statements taken as a whole. There was no impact on the consolidated amounts previously reported.




34

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – continued (Unaudited)
ACE Limited and Subsidiaries


Condensed Consolidating Balance Sheet at June 30, 2014
(in millions of U.S. dollars)
ACE
Limited
(Parent
Guarantor)

 
ACE INA
Holdings Inc.
(Subsidiary
Issuer)

 
Other ACE
Limited
Subsidiaries

 
Consolidating
Adjustments and Eliminations

 
ACE Limited
Consolidated

Assets
 
 
 
 
 
 
 
 
 
Investments
$
33

 
$
11

 
$
63,576

 
$
—

 
$
63,620

Cash(1)
44

 
1

 
1,026

 
(477
)
 
594

Insurance and reinsurance balances receivable
—

 
—

 
6,169

 
(853
)
 
5,316

Reinsurance recoverable on losses and loss expenses
—

 
—

 
19,609

 
(8,841
)
 
10,768

Reinsurance recoverable on policy benefits
—

 
—

 
1,260

 
(1,026
)
 
234

Value of business acquired
—

 
—

 
514

 
—

 
514

Goodwill and other intangible assets
—

 
—

 
5,522

 
—

 
5,522

Investments in subsidiaries
30,207

 
18,946

 
—

 
(49,153
)
 
—

Due from subsidiaries and affiliates, net
305

 
—

 
—

 
(305
)
 
—

Other assets
4

 
295

 
14,300

 
(3,720
)
 
10,879

Total assets
$
30,593

 
$
19,253

 
$
111,976

 
$
(64,375
)
 
$
97,447

Liabilities
 
 
 
 
 
 
 
 
 
Unpaid losses and loss expenses
$
—

 
$
—

 
$
45,589

 
$
(8,412
)
 
$
37,177

Unearned premiums
—

 
—

 
10,154

 
(1,858
)
 
8,296

Future policy benefits
—

 
—

 
5,804

 
(1,026
)
 
4,778

Due to (from) subsidiaries and affiliates, net
—

 
78

 
227

 
(305
)
 
—

Affiliated notional cash pooling programs(1)
—

 
477

 
—

 
(477
)
 
—

Short-term debt
—

 
450

 
1,401

 
—

 
1,851

Long-term debt
—

 
4,045

 
12

 
—

 
4,057

Trust preferred securities
—

 
309

 
—

 
—

 
309

Other liabilities
268

 
1,418

 
12,112

 
(3,144
)
 
10,654

Total liabilities
268

 
6,777

 
75,299

 
(15,222
)
 
67,122

Total shareholders’ equity
30,325

 
12,476

 
36,677

 
(49,153
)
 
30,325

Total liabilities and shareholders’ equity
$
30,593

 
$
19,253

 
$
111,976

 
$
(64,375
)
 
$
97,447

(1) 
ACE maintains two notional multicurrency cash pools (Pools) with a third-party bank. Various ACE entities participate in one or the other of the Pools, pursuant to which credit and debit balances in individual ACE accounts are translated daily into a single currency and pooled on a notional basis. Individual ACE entities are permitted to overdraw on their individual accounts provided the overall Pool balances do not fall below zero. At June 30, 2014, the cash balance of one or more entities was negative; however, the overall Pool balances were positive.
 






35

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – continued (Unaudited)
ACE Limited and Subsidiaries


Condensed Consolidating Balance Sheet at December 31, 2013

(in millions of U.S. dollars)
ACE
Limited
(Parent
Guarantor)

 
ACE INA
Holdings Inc.
(Subsidiary
Issuer)

 
Other ACE
Limited
Subsidiaries

 
Consolidating
Adjustments and Eliminations

 
ACE Limited
Consolidated

Assets
 
 
 
 
 
 
 
 
 
Investments
$
32

 
$
10

 
$
60,886

 
$
—

 
$
60,928

Cash(1)
—

 
16

 
748

 
(185
)
 
579

Insurance and reinsurance balances receivable
—

 
—

 
5,835

 
(809
)
 
5,026

Reinsurance recoverable on losses and loss expenses
—

 
—

 
20,057

 
(8,830
)
 
11,227

Reinsurance recoverable on policy benefits
—

 
—

 
1,215

 
(997
)
 
218

Value of business acquired
—

 
—

 
536

 
—

 
536

Goodwill and other intangible assets
—

 
—

 
5,404

 
—

 
5,404

Investments in subsidiaries
28,351

 
18,105

 
—

 
(46,456
)
 
—

Due from subsidiaries and affiliates, net
844

 
—

 
—

 
(844
)
 


Other assets
5

 
258

 
13,788

 
(3,459
)
 
10,592

Total assets
$
29,232

 
$
18,389

 
$
108,469

 
$
(61,580
)
 
$
94,510

Liabilities
 
 
 
 
 
 
 
 
 
Unpaid losses and loss expenses
$
—

 
$
—

 
$
45,714

 
$
(8,271
)
 
$
37,443

Unearned premiums
—

 
—

 
9,242

 
(1,703
)
 
7,539

Future policy benefits
—

 
—

 
5,612

 
(997
)
 
4,615

Due to (from) subsidiaries and affiliates, net
—

 
714

 
130

 
(844
)
 
—

Affiliated notional cash pooling programs(1)
185

 
—

 
—

 
(185
)
 
—

Short-term debt
—

 
500

 
1,401

 
—

 
1,901

Long-term debt
—

 
3,795

 
12

 
—

 
3,807

Trust preferred securities
—

 
309

 
—

 
—

 
309

Other liabilities
222

 
1,318

 
11,655

 
(3,124
)
 
10,071

Total liabilities
407

 
6,636

 
73,766

 
(15,124
)
 
65,685

Total shareholders’ equity
28,825

 
11,753

 
34,703

 
(46,456
)
 
28,825

Total liabilities and shareholders’ equity
$
29,232

 
$
18,389

 
$
108,469

 
$
(61,580
)
 
$
94,510

(1) 
ACE maintains two notional multicurrency cash pools (Pools) with a third-party bank. Various ACE entities participate in one or the other of the Pools, pursuant to which credit and debit balances in individual ACE accounts are translated daily into a single currency and pooled on a notional basis. Individual ACE entities are permitted to overdraw on their individual accounts provided the overall Pool balances do not fall below zero. At December 31, 2013, the cash balance of one or more entities was negative; however, the overall Pool balances were positive.


36

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – continued (Unaudited)
ACE Limited and Subsidiaries



Condensed Consolidating Statements of Operations and Comprehensive Income
For the Three Months Ended June 30, 2014
ACE
Limited
(Parent
Guarantor)

 
ACE INA
Holdings Inc.
(Subsidiary
Issuer)

 
Other ACE
Limited
Subsidiaries

 
Consolidating
Adjustments and Eliminations

 
ACE
Limited
Consolidated

(in millions of U.S. dollars)
 
 
 
 
Net premiums written
$
—

 
$
—

 
$
4,559

 
$
—

 
$
4,559

Net premiums earned
—

 
—

 
4,332

 
—

 
4,332

Net investment income
1

 
1

 
554

 
—

 
556

Equity in earnings of subsidiaries
745

 
231

 
—

 
(976
)
 
—

Net realized gains (losses) including OTTI
—

 
8

 
(81
)
 
—

 
(73
)
Losses and loss expenses
—

 
—

 
2,388

 
—

 
2,388

Policy benefits
—

 
—

 
144

 
—

 
144

Policy acquisition costs and administrative expenses
22

 
8

 
1,294

 
—

 
1,324

Interest (income) expense
(9
)
 
70

 
11

 
—

 
72

Other (income) expense
(50
)
 
6

 
19

 
—

 
(25
)
Income tax expense (benefit)
4

 
(25
)
 
154

 
—

 
133

Net income
$
779

 
$
181

 
$
795

 
$
(976
)
 
$
779

Comprehensive income
$
1,348

 
$
511

 
$
1,364

 
$
(1,875
)
 
$
1,348


Condensed Consolidating Statements of Operations and Comprehensive Income (Revised)
For the Three Months Ended June 30, 2013
ACE
Limited
(Parent
Guarantor)

 
ACE INA
Holdings Inc.
(Subsidiary
Issuer)

 
Other ACE
Limited
Subsidiaries

 
Consolidating
Adjustments and Eliminations

 
ACE
Limited
Consolidated

(in millions of U.S. dollars)
 
 
 
 
Net premiums written
$
—

 
$
—

 
$
4,391

 
$
—

 
$
4,391

Net premiums earned
—

 
—

 
4,067

 
—

 
4,067

Net investment income
1

 
1

 
532

 
—

 
534

Equity in earnings of subsidiaries
842

 
257

 
—

 
(1,099
)
 
—

Net realized gains (losses) including OTTI
—

 
—

 
104

 
—

 
104

Losses and loss expenses
—

 
—

 
2,250

 
—

 
2,250

Policy benefits
—

 
—

 
110

 
—

 
110

Policy acquisition costs and administrative expenses
12

 
5

 
1,212

 
—

 
1,229

Interest (income) expense
(8
)
 
69

 
12

 
—

 
73

Other (income) expense
(57
)
 
6

 
88

 
—

 
37

Income tax expense (benefit)
5

 
(33
)
 
143

 
—

 
115

Net income
$
891

 
$
211

 
$
888

 
$
(1,099
)
 
$
891

Comprehensive loss
$
(499
)
 
$
(533
)
 
$
(502
)
 
$
1,035

 
$
(499
)



37

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – continued (Unaudited)
ACE Limited and Subsidiaries


Condensed Consolidating Statements of Operations and Comprehensive Income (As previously reported)
For the Three Months Ended June 30, 2013
ACE
Limited
(Parent
Guarantor)

 
ACE INA
Holdings Inc.
(Subsidiary
Issuer)

 
Other ACE
Limited
Subsidiaries and
Eliminations(1)

 
Consolidating
Adjustments (2)

 
ACE
Limited
Consolidated

(in millions of U.S. dollars)
 
 
 
 
Net premiums written
$
—

 
$
2,502

 
$
1,889

 
$
—

 
$
4,391

Net premiums earned
—

 
2,331

 
1,736

 
—

 
4,067

Net investment income
1

 
254

 
279

 
—

 
534

Equity in earnings of subsidiaries
842

 
—

 
—

 
(842
)
 
—

Net realized gains (losses) including OTTI
—

 
28

 
76

 
—

 
104

Losses and loss expenses
—

 
1,434

 
816

 
—

 
2,250

Policy benefits
—

 
63

 
47

 
—

 
110

Policy acquisition costs and administrative expenses
12

 
674

 
543

 
—

 
1,229

Interest (income) expense
(8
)
 
74

 
7

 
—

 
73

Other (income) expense
(57
)
 
65

 
29

 
—

 
37

Income tax expense
5

 
92

 
18

 
—

 
115

Net income
$
891

 
$
211

 
$
631

 
$
(842
)
 
$
891

Comprehensive income (loss)
$
(499
)
 
$
(533
)
 
$
1,375

 
$
(842
)
 
$
(499
)
(1) 
Includes all other subsidiaries of ACE Limited and intercompany eliminations.
(2) 
Includes ACE Limited parent company eliminations.

Condensed Consolidating Statements of Operations and Comprehensive Income
For the Six Months Ended June 30, 2014
ACE
Limited
(Parent
Guarantor)

 
ACE INA
Holdings Inc.
(Subsidiary
Issuer)

 
Other ACE
Limited
Subsidiaries

 
Consolidating
Adjustments and Eliminations

 
ACE
Limited
Consolidated

(in millions of U.S. dollars)
 
 
 
 
Net premiums written
$
—

 
$
—

 
$
8,744

 
$
—

 
$
8,744

Net premiums earned
—

 
—

 
8,302

 
—

 
8,302

Net investment income
1

 
1

 
1,107

 
—

 
1,109

Equity in earnings of subsidiaries
1,447

 
411

 
—

 
(1,858
)
 
—

Net realized gains (losses) including OTTI
—

 
7

 
(184
)
 
—

 
(177
)
Losses and loss expenses
—

 
—

 
4,549

 
—

 
4,549

Policy benefits
—

 
—

 
258

 
—

 
258

Policy acquisition costs and administrative expenses
39

 
14

 
2,534

 
—

 
2,587

Interest (income) expense
(19
)
 
141

 
21

 
—

 
143

Other (income) expense
(92
)
 
20

 
30

 
—

 
(42
)
Income tax expense (benefit)
7

 
(55
)
 
274

 
—

 
226

Net income
$
1,513

 
$
299

 
$
1,559

 
$
(1,858
)
 
$
1,513

Comprehensive income
$
2,456

 
$
777

 
$
2,502

 
$
(3,279
)
 
$
2,456



38

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – continued (Unaudited)
ACE Limited and Subsidiaries


Condensed Consolidating Statements of Operations and Comprehensive Income (Revised)
For the Six Months Ended June 30, 2013
ACE
Limited
(Parent
Guarantor)

 
ACE INA
Holdings Inc.
(Subsidiary
Issuer)

 
Other ACE
Limited
Subsidiaries

 
Consolidating
Adjustments and Eliminations

 
ACE
Limited
Consolidated

(in millions of U.S. dollars)
 
 
 
 
Net premiums written
$
—

 
$
—

 
$
8,189

 
$
—

 
$
8,189

Net premiums earned
—

 
—

 
7,640

 
—

 
7,640

Net investment income
1

 
2

 
1,062

 
—

 
1,065

Equity in earnings of subsidiaries
1,756

 
445

 
—

 
(2,201
)
 
—

Net realized gains (losses) including OTTI
12

 
—

 
298

 
—

 
310

Losses and loss expenses
—

 
—

 
4,176

 
—

 
4,176

Policy benefits
—

 
—

 
241

 
—

 
241

Policy acquisition costs and administrative expenses
27

 
9

 
2,321

 
—

 
2,357

Interest (income) expense
(15
)
 
131

 
17

 
—

 
133

Other (income) expense
(95
)
 
15

 
107

 
—

 
27

Income tax expense (benefit)
8

 
(66
)
 
295

 
—

 
237

Net income
$
1,844

 
$
358

 
$
1,843

 
$
(2,201
)
 
$
1,844

Comprehensive income (loss)
$
217

 
$
(534
)
 
$
216

 
$
318

 
$
217



Condensed Consolidating Statements of Operations and Comprehensive Income (As previously reported)
For the Six Months Ended June 30, 2013
ACE
Limited
(Parent
Guarantor)

 
ACE INA
Holdings Inc.
(Subsidiary
Issuer)

 
Other ACE
Limited
Subsidiaries and
Eliminations(1)

 
Consolidating
Adjustments (2)

 
ACE
Limited
Consolidated

(in millions of U.S. dollars)
 
 
 
 
Net premiums written
$
—

 
$
4,584

 
$
3,605

 
$
—

 
$
8,189

Net premiums earned
—

 
4,337

 
3,303

 
—

 
7,640

Net investment income
1

 
502

 
562

 
—

 
1,065

Equity in earnings of subsidiaries
1,756

 
—

 
—

 
(1,756
)
 
—

Net realized gains (losses) including OTTI
12

 
38

 
260

 
—

 
310

Losses and loss expenses
—

 
2,687

 
1,489

 
—

 
4,176

Policy benefits
—

 
144

 
97

 
—

 
241

Policy acquisition costs and administrative expenses
27

 
1,300

 
1,030

 
—

 
2,357

Interest (income) expense
(15
)
 
141

 
7

 
—

 
133

Other (income) expense
(95
)
 
99

 
23

 
—

 
27

Income tax expense
8

 
148

 
81

 
—

 
237

Net income
$
1,844

 
$
358

 
$
1,398

 
$
(1,756
)
 
$
1,844

Comprehensive income (loss)
$
217

 
$
(534
)
 
$
2,290

 
$
(1,756
)
 
$
217

(1) 
Includes all other subsidiaries of ACE Limited and intercompany eliminations.
(2) 
Includes ACE Limited parent company eliminations.



39

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – continued (Unaudited)
ACE Limited and Subsidiaries


Condensed Consolidating Statement of Cash Flows
For the Six Months Ended June 30, 2014
ACE
Limited
(Parent
Guarantor)

 
ACE INA
Holdings Inc.
(Subsidiary
Issuer)

 
Other ACE
Limited
Subsidiaries

 
Consolidating
Adjustments and Eliminations

 
ACE
Limited
Consolidated

(in millions of U.S. dollars)
 
 
 
 
Net cash flows from (used for) operating activities
$
83

 
$
(7
)
 
$
2,020

 
$
—

 
$
2,096

Cash flows from investing activities
 
 
 
 
 
 
 
 
 
Purchases of fixed maturities available for sale
—

 
—

 
(7,963
)
 
3

 
(7,960
)
Purchases of fixed maturities held to maturity
—

 
—

 
(129
)
 
—

 
(129
)
Purchases of equity securities
—

 
—

 
(64
)
 
—

 
(64
)
Sales of fixed maturities available for
sale
—

 
—

 
3,845

 
(3
)
 
3,842

Sales of equity securities
—

 
—

 
45

 
—

 
45

Maturities and redemptions of fixed maturities available for sale
—

 
—

 
3,163

 
—

 
3,163

Maturities and redemptions of fixed maturities held to maturity
—

 
—

 
414

 
—

 
414

Net change in short-term investments
(1
)
 
(1
)
 
(293
)
 
—

 
(295
)
Net derivative instruments settlements
—

 
(7
)
 
(178
)
 
—

 
(185
)
Acquisition of subsidiaries (net of cash acquired of $4)
—

 
—

 
(172
)
 
—

 
(172
)
Other
—

 
(3
)
 
(115
)
 
—

 
(118
)
Net cash flows used for investing activities
(1
)
 
(11
)
 
(1,447
)
 
—

 
(1,459
)
Cash flows from financing activities
 
 
 
 
 
 
 
 
 
Dividends paid on Common Shares
(428
)
 
—

 
—

 
—

 
(428
)
Common Shares repurchased
—

 
—

 
(557
)
 
—

 
(557
)
Proceeds from issuance of long-term debt
—

 
699

 
—

 
—

 
699

Repayment of long-term debt
—

 
(500
)
 
—

 
—

 
(500
)
Proceeds from share-based compensation plans, including windfall tax benefits
—

 
—

 
75

 
—

 
75

Advances (to) from affiliates
575

 
(667
)
 
92

 
—

 
—

Net proceeds from (payments to) affiliated notional cash pooling programs(1)
(185
)
 
477

 
—

 
(292
)
 
—

Other
—

 
(6
)
 
92

 
—

 
86

Net cash flows (used for) from financing activities
(38
)
 
3

 
(298
)
 
(292
)
 
(625
)
Effect of foreign currency rate changes on cash and cash equivalents
—

 
—

 
3

 
—

 
3

Net increase (decrease) in cash
44

 
(15
)
 
278

 
(292
)
 
15

Cash – beginning of period(1)
—

 
16

 
748

 
(185
)
 
579

Cash – end of period(1)
$
44

 
$
1

 
$
1,026

 
$
(477
)
 
$
594

(1) 
ACE maintains two notional multicurrency cash pools (Pools) with a third-party bank. Various ACE entities participate in one or the other of the Pools, pursuant to which credit and debit balances in individual ACE accounts are translated daily into a single currency and pooled on a notional basis. Individual ACE entities are permitted to overdraw on their individual accounts provided the overall Pool balances do not fall below zero. At June 30, 2014 and December 31, 2013, the cash balance of one or more entities was negative; however, the overall Pool balances were positive.



40

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – continued (Unaudited)
ACE Limited and Subsidiaries


Condensed Consolidating Statement of Cash Flows (Revised)
For the Six Months Ended June 30, 2013
ACE
Limited
(Parent
Guarantor)

 
ACE INA
Holdings Inc.
(Subsidiary
Issuer)

 
Other ACE
Limited
Subsidiaries

 
Consolidating
Adjustments and Eliminations

 
ACE
Limited
Consolidated

(in millions of U.S. dollars)
 
 
 
 
Net cash flows from (used for) operating activities
$
18

 
$
(38
)
 
$
1,828

 
$
—

 
$
1,808

Cash flows from investing activities
 
 
 
 
 
 
 
 
 
Purchases of fixed maturities available for sale
—

 
—

 
(10,907
)
 
103

 
(10,804
)
Purchases of fixed maturities held to maturity
—

 
—

 
(299
)
 
—

 
(299
)
Purchases of equity securities
—

 
—

 
(194
)
 
—

 
(194
)
Sales of fixed maturities available for sale
—

 
—

 
5,499

 
(103
)
 
5,396

Sales of equity securities
—

 
—

 
62

 
—

 
62

Maturities and redemptions of fixed maturities available for sale
—

 
—

 
4,112

 
—

 
4,112

Maturities and redemptions of fixed maturities held to maturity
—

 
—

 
908

 
—

 
908

Net change in short-term investments
—

 
3

 
(140
)
 
—

 
(137
)
Net derivative instruments settlements
—

 
—

 
(317
)
 
—

 
(317
)
Acquisition of subsidiaries (net of cash acquired of $38)
—

 
—

 
(977
)
 
—

 
(977
)
Capital contribution
(119
)
 
(1,010
)
 
—

 
1,129

 
—

Other
—

 
—

 
(126
)
 
—

 
(126
)
Net cash flows used for investing activities
(119
)
 
(1,007
)
 
(2,379
)
 
1,129

 
(2,376
)
Cash flows from financing activities
 
 
 
 
 
 
 
 
 
Dividends paid on Common Shares
(169
)
 
—

 
—

 
—

 
(169
)
Common Shares repurchased
—

 
—

 
(212
)
 
—

 
(212
)
Net proceeds from issuance of long-term debt
—

 
947

 
—

 
—

 
947

Advances (to) from affiliates
(352
)
 
352

 
—

 
—

 
—

Net payments to affiliated notional cash pooling programs(1)
513

 
(253
)
 
—

 
(260
)
 
—

Proceeds from exercise of options for Common Shares
6

 
—

 
56

 
—

 
62

Capital contribution
—

 
—

 
1,129

 
(1,129
)
 
—

Other
—

 
—

 
30

 
—

 
30

Net cash flows from (used for) financing activities
(2
)
 
1,046

 
1,003

 
(1,389
)
 
658

Effect of foreign currency rate changes on cash and cash equivalents
—

 
—

 
(26
)
 
—

 
(26
)
Net increase (decrease) in cash
(103
)
 
1

 
426

 
(260
)
 
64

Cash – beginning of period(1)
103

 
2

 
859

 
(349
)
 
615

Cash – end of period(1)
$
—

 
$
3

 
$
1,285

 
$
(609
)
 
$
679

(1) 
ACE maintains two notional multicurrency cash pools (Pools) with a third-party bank. Various ACE entities participate in one or the other of the Pools, pursuant to which credit and debit balances in individual ACE accounts are translated daily into a single currency and pooled on a notional basis. Individual ACE entities are permitted to overdraw on their individual accounts provided the overall Pool balances do not fall below zero. At June 30, 2013 and December 31, 2012, the cash balance of one or more entities was negative; however, the overall Pool balances were positive.


41

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – continued (Unaudited)
ACE Limited and Subsidiaries


Condensed Consolidating Statement of Cash Flows (As previously reported)
For the Six Months Ended June 30, 2013
ACE
Limited
(Parent
Guarantor)

 
ACE INA
Holdings Inc.
(Subsidiary
Issuer)

 
Other ACE
Limited
Subsidiaries and
Eliminations(1)

 
Consolidating
Adjustments(2)

 
ACE
Limited
Consolidated

(in millions of U.S. dollars)
 
 
 
 
Net cash flows from operating activities
$
95

 
$
876

 
$
837

 
$
—

 
$
1,808

Cash flows from investing activities
 
 
 
 
 
 
 
 
 
Purchases of fixed maturities available for sale
—

 
(6,604
)
 
(4,337
)
 
—

 
(10,941
)
Purchases of fixed maturities held to maturity
—

 
(284
)
 
(15
)
 
—

 
(299
)
Purchases of equity securities
—

 
(161
)
 
(33
)
 
—

 
(194
)
Sales of fixed maturities available for sale
—

 
3,571

 
1,825

 
—

 
5,396

Sales of equity securities
—

 
51

 
11

 
—

 
62

Maturities and redemptions of fixed maturities available for sale
—

 
1,839

 
2,273

 
—

 
4,112

Maturities and redemptions of fixed maturities held to maturity
—

 
613

 
295

 
—

 
908

Net derivative instruments settlements
—

 
10

 
(327
)
 
—

 
(317
)
Advances to affiliates
(429
)
 
—

 
—

 
429

 
—

Acquisition of subsidiaries (net of cash acquired of $38)
—

 
(977
)
 
—

 
—

 
(977
)
Capital contribution
(119
)
 
—

 
—

 
119

 
—

Other
—

 
(154
)
 
28

 
—

 
(126
)
Net cash flows used for investing activities
(548
)
 
(2,096
)
 
(280
)
 
548

 
(2,376
)
Cash flows from financing activities
 
 
 
 
 
 
 
 
 
Dividends paid on Common Shares
(169
)
 
—

 
—

 
—

 
(169
)
Common Shares repurchased
—

 
—

 
(212
)
 
—

 
(212
)
Proceeds from issuance of long-term debt
—

 
947

 
—

 
—

 
947

Proceeds from share-based compensation plans, including windfall tax benefits
6

 
(4
)
 
60

 
—

 
62

Advances from affiliates
—

 
352

 
77

 
(429
)
 
—

Capital contribution
—

 
—

 
119

 
(119
)
 
—

Other
—

 
30

 
—

 
—

 
30

Net cash flows from (used for) financing activities
(163
)
 
1,325

 
44

 
(548
)
 
658

Effect of foreign currency rate changes on cash and cash equivalents
—

 
(37
)
 
11

 
—

 
(26
)
Net increase (decrease) in cash
(616
)
 
68

 
612

 
—

 
64

Cash – beginning of period(3)
103

 
515

 
(3
)
 
—

 
615

Cash – end of period(3)
$
(513
)
 
$
583

 
$
609

 
$
—

 
$
679

(1)
Includes all other subsidiaries of ACE Limited and intercompany eliminations.
(2)
Includes ACE Limited parent company eliminations and certain consolidating adjustments.
(3)
ACE maintains two notional multicurrency cash pools (Pools) with a third-party bank. Various ACE entities participate in one or the other of the Pools, pursuant to which credit and debit balances in individual ACE accounts are translated daily into a single currency and pooled on a notional basis. Individual ACE entities are permitted to overdraw on their individual accounts provided the overall Pool balances do not fall below zero. At June 30, 2013 and December 31, 2012, the cash balance of one or more entities was negative; however, the overall Pool balances were positive.



42

ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following is a discussion of our results of operations, financial condition, and liquidity and capital resources as of and for the three and six months ended June 30, 2014.

All comparisons in this discussion are to the corresponding prior year periods unless otherwise indicated.

Our results of operations and cash flows for any interim period are not necessarily indicative of our results for the full year. This discussion should be read in conjunction with our consolidated financial statements and related notes and our Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the year ended December 31, 2013 (2013 Form 10-K).

Other Information
We routinely post important information for investors on our website (www.acegroup.com) under the Investor Information section. We use this website as a means of disclosing material, non-public information and for complying with our disclosure obligations under Securities and Exchange Commission (SEC) Regulation FD (Fair Disclosure). Accordingly, investors should monitor the Investor Information portion of our website, in addition to following our press releases, SEC filings, public conference calls, and webcasts. The information contained on, or that may be accessed through, our website is not incorporated by reference into, and is not a part of, this report.



43

______________________________________________________________________________________________________________________
Forward-Looking Statements
The Private Securities Litigation Reform Act of 1995 provides a “safe harbor” for forward-looking statements. Any written or oral statements made by us or on our behalf may include forward-looking statements that reflect our current views with respect to future events and financial performance. These forward-looking statements are subject to certain risks, uncertainties, and other factors that could, should potential events occur, cause actual results to differ materially from such statements. These risks, uncertainties, and other factors, which are described in more detail elsewhere herein and in other documents we file with the U.S. Securities and Exchange Commission (SEC), include but are not limited to:
•
losses arising out of natural or man-made catastrophes such as hurricanes, typhoons, earthquakes, floods, climate change (including effects on weather patterns; greenhouse gases; sea; land and air temperatures; sea levels; and rain and snow), nuclear accidents, or terrorism which could be affected by:
•
the number of insureds and ceding companies affected;
•
the amount and timing of losses actually incurred and reported by insureds;
•
the impact of these losses on our reinsurers and the amount and timing of reinsurance recoverable actually received;
•
the cost of building materials and labor to reconstruct properties or to perform environmental remediation following a catastrophic event; and
•
complex coverage and regulatory issues such as whether losses occurred from storm surge or flooding and related lawsuits;
•
actions that rating agencies may take from time to time, such as financial strength or credit ratings downgrades or placing these ratings on credit watch negative or the equivalent;
•
the ability to collect reinsurance recoverable, credit developments of reinsurers, and any delays with respect thereto and changes in the cost, quality, or availability of reinsurance;
•
actual loss experience from insured or reinsured events and the timing of claim payments;
•
the uncertainties of the loss-reserving and claims-settlement processes, including the difficulties associated with assessing environmental damage and asbestos-related latent injuries, the impact of aggregate-policy-coverage limits, the impact of bankruptcy protection sought by various asbestos producers and other related businesses, and the timing of loss payments;
•
changes to our assessment as to whether it is more likely than not that we will be required to sell, or have the intent to sell, available for sale fixed maturity investments before their anticipated recovery;
•
infection rates and severity of pandemics and their effects on our business operations and claims activity;
•
developments in global financial markets, including changes in interest rates, stock markets, and other financial markets, increased government involvement or intervention in the financial services industry, the cost and availability of financing, and foreign currency exchange rate fluctuations (which we refer to in this report as foreign exchange and foreign currency exchange), which could affect our statement of operations, investment portfolio, financial condition, and financing plans;
•
general economic and business conditions resulting from volatility in the stock and credit markets and the depth and duration of potential recession;
•
global political conditions, the occurrence of any terrorist attacks, including any nuclear, radiological, biological, or chemical events, or the outbreak and effects of war, and possible business disruption or economic contraction that may result from such events;
•
judicial decisions and rulings, new theories of liability, legal tactics, and settlement terms;
•
the effects of public company bankruptcies and/or accounting restatements, as well as disclosures by and investigations of public companies relating to possible accounting irregularities, and other corporate governance issues, including the effects of such events on:
•
the capital markets;
•
the markets for directors and officers (D&O) and errors and omissions (E&O) insurance; and
•
claims and litigation arising out of such disclosures or practices by other companies;


44

•
uncertainties relating to governmental, legislative and regulatory policies, developments, actions, investigations, and treaties, which, among other things, could subject us to insurance regulation or taxation in additional jurisdictions or affect our current operations;
•
the actual amount of new and renewal business, market acceptance of our products, and risks associated with the introduction of new products and services and entering new markets, including regulatory constraints on exit strategies;
•
the competitive environment in which we operate, including trends in pricing or in policy terms and conditions, which may differ from our projections and changes in market conditions that could render our business strategies ineffective or obsolete;
•
acquisitions made by us performing differently than expected, our failure to realize anticipated expense-related efficiencies or growth from acquisitions, the impact of acquisitions on our pre-existing organization, or announced acquisitions not closing;
•
risks associated with being a Swiss corporation, including reduced flexibility with respect to certain aspects of capital management and the potential for additional regulatory burdens;
•
the potential impact from government-mandated insurance coverage for acts of terrorism;
•
the availability of borrowings and letters of credit under our credit facilities;
•
the adequacy of collateral supporting funded high deductible programs;
•
changes in the distribution or placement of risks due to increased consolidation of insurance and reinsurance brokers;
•
material differences between actual and expected assessments for guaranty funds and mandatory pooling arrangements;
•
the effects of investigations into market practices in the property and casualty (P&C) industry;
•
changing rates of inflation and other economic conditions, for example, recession;
•
the amount of dividends received from subsidiaries;
•
loss of the services of any of our executive officers without suitable replacements being recruited in a reasonable time frame;
•
the ability of our technology resources, including information systems and security, to perform as anticipated; and
•
management’s response to these factors and actual events (including, but not limited to, those described above).
The words “believe,” “anticipate,” “estimate,” “project,” “should,” “plan,” “expect,” “intend,” “hope,” “feel,” “foresee,” “will likely result,” or “will continue,” and variations thereof and similar expressions, identify forward-looking statements. You are cautioned not to place undue reliance on these forward-looking statements, which speak only as of their dates. We undertake no obligation to publicly update or review any forward-looking statements, whether as a result of new information, future events, or otherwise.


45

______________________________________________________________________________________________________________________
Overview
ACE Limited is the Swiss-incorporated holding company of the ACE Group of Companies. ACE Limited, which is headquartered in Zurich, Switzerland, and its direct and indirect subsidiaries (collectively, the ACE Group of Companies, ACE, we, us, or our) are a global insurance and reinsurance organization, serving the needs of a diverse group of clients worldwide. At June 30, 2014, we had total assets of $97 billion and shareholders’ equity of $30 billion. ACE opened its first business office in Bermuda, in 1985, and continues to maintain operations in Bermuda.

We operate through five business segments: Insurance – North American P&C, Insurance – North American Agriculture, Insurance – Overseas General, Global Reinsurance, and Life. For more information on our segments refer to “Segment Information” in our 2013 Form 10-K.

We have grown our business through increased premium volume, expansion of product offerings and geographic reach, and acquisitions of other companies. The Insurance – Overseas General segment has recently expanded its operations through the following acquisitions:

•
The Siam Commercial Samaggi Insurance PCL (Samaggi) (we and our local partner acquired 60.86 percent ownership on April 28, 2014, and subsequently acquired an additional 32.17 percent ownership through a mandatory tender offer, which expired on June 17, 2014);
•
ABA Seguros (May 2, 2013); and
•
Fianzas Monterrey (April 1, 2013).

The consolidated financial statements include results of acquired businesses from the acquisition dates. Refer to Note 2 to the Consolidated Financial Statements for additional information on our acquisitions.

______________________________________________________________________________________________________________________
Financial Highlights for the Three Months Ended June 30, 2014

•
Net income was $779 million compared with $891 million in the prior year period.
•
Total company net premiums written increased 3.8 percent, or 4.5 percent on a constant-dollar basis.
•
The P&C combined ratio was 87.7 percent compared with 87.9 percent in the prior year period.
•
The current accident year P&C combined ratio excluding catastrophe losses was 88.9 percent compared with 89.2 percent in the prior year period.
•
The P&C expense ratio was 29.3 percent compared with 29.2 percent in the prior year period.
•
Total pre-tax and after-tax catastrophe losses including reinstatement premiums were $80 million (2.1 percentage points of the combined ratio) and $67 million, respectively, compared with $81 million (2.3 percentage points of the combined ratio) and $66 million, respectively, in the prior year period.
•
Favorable prior period development pre-tax and after-tax were $126 million (3.3 percentage points of the combined ratio) and $106 million, respectively, compared with $128 million (3.6 percentage points of the combined ratio) and $109 million, respectively, in the prior year period.
•
Operating cash flow was $846 million for the quarter.
•
Net investment income increased 4.2 percent to $556 million.
•
Share repurchases totaled $237 million, or approximately 2.3 million shares, during the quarter.


46

__________________________________________________________________________________________________________
Consolidated Operating Results – Three and Six Months Ended June 30, 2014 and 2013
 
Three Months Ended
 
 
 
 
Six Months Ended
 
 
 
 
June 30
 
 
% Change

 
June 30
 
 
% Change

(in millions of U.S. dollars, except for percentages)
2014

 
2013

 
Q-14 vs.
Q-13

 
2014

 
2013

 
YTD-14 vs.
YTD-13

Net premiums written
$
4,559

 
$
4,391

 
3.8
 %
 
$
8,744

 
$
8,189

 
6.8
 %
Net premiums earned
4,332

 
4,067

 
6.5
 %
 
8,302

 
7,640

 
8.7
 %
Net investment income
556

 
534

 
4.2
 %
 
1,109

 
1,065

 
4.1
 %
Net realized gains (losses)
(73
)
 
104

 
NM

 
(177
)
 
310

 
NM

Total revenues
4,815

 
4,705

 
2.3
 %
 
9,234

 
9,015

 
2.4
 %
Losses and loss expenses
2,388

 
2,250

 
6.1
 %
 
4,549

 
4,176

 
8.9
 %
Policy benefits
144

 
110

 
30.9
 %
 
258

 
241

 
7.1
 %
Policy acquisition costs
758

 
665

 
14.0
 %
 
1,486

 
1,279

 
16.2
 %
Administrative expenses
566

 
564

 
0.4
 %
 
1,101

 
1,078

 
2.1
 %
Interest expense
72

 
73

 
(1.4
)%
 
143

 
133

 
7.5
 %
Other (income) expense
(25
)
 
37

 
NM

 
(42
)
 
27

 
NM

Total expenses
3,903

 
3,699

 
5.5
 %
 
7,495

 
6,934

 
8.1
 %
Income before income tax
912

 
1,006

 
(9.3
)%
 
1,739

 
2,081

 
(16.4
)%
Income tax expense
133

 
115

 
15.7
 %
 
226

 
237

 
(4.6
)%
Net income
$
779

 
$
891

 
(12.5
)%
 
$
1,513

 
$
1,844

 
(18.0
)%
NM – not meaningful
 
 
 
 
 
 
 
 
 
 
 



47

The following tables present a breakdown of consolidated net premiums written for the periods indicated:
 
Three Months Ended
 
 
 
 
Six Months Ended
 
 
 
 
June 30
 
 
% Change

 
June 30
 
 
% Change

(in millions of U.S. dollars, except for percentages)
2014

 
2013

 
Q-14 vs.
Q-13

 
2014

 
2013

 
YTD-14 vs.
YTD-13

Commercial P&C (retail and wholesale)
$
2,067

 
$
1,964

 
5.2
 %
 
$
4,076

 
$
3,846

 
6.0
%
Personal and small commercial lines
614

 
522

 
17.6
 %
 
1,124

 
891

 
26.1
%
Reinsurance
278

 
292

 
(4.9
)%
 
586

 
571

 
2.5
%
Property, casualty, and all other
2,959

 
2,778

 
6.5
 %
 
5,786

 
5,308

 
9.0
%
Agriculture
388

 
453

 
(14.2
)%
 
582

 
566

 
3.0
%
Personal accident (A&H)
961

 
925

 
3.9
 %
 
1,878

 
1,839

 
2.1
%
Life
251

 
235

 
6.9
 %
 
498

 
476

 
4.6
%
Total consolidated
$
4,559

 
$
4,391

 
3.8
 %
 
$
8,744

 
$
8,189

 
6.8
%
Total consolidated - constant dollars (C$) (1)
 
 
$
4,362

 
4.5
 %
 
 
 
$
8,097

 
8.0
%
 
 
 
 
 
 
 
 
 
 
 
 
 
2014
% of Total

 
2013
% of Total

 
 
 
2014
% of Total

 
2013
% of Total

 
 
Commercial P&C (retail and wholesale)
45
%
 
45
%
 
 
 
46
%
 
47
%
 
 
Personal and small commercial lines
14
%
 
12
%
 
 
 
13
%
 
11
%
 
 
Reinsurance
6
%
 
6
%
 
 
 
7
%
 
7
%
 
 
Property, casualty, and all other
65
%
 
63
%
 
 
 
66
%
 
65
%
 
 
Agriculture
8
%
 
11
%
 
 
 
7
%
 
7
%
 
 
Personal accident (A&H)
21
%
 
21
%
 
 
 
21
%
 
22
%
 
 
Life
6
%
 
5
%
 
 
 
6
%
 
6
%
 
 
Total consolidated
100
%
 
100
%
 
 
 
100
%
 
100
%
 
 
(1)
On a constant-dollar basis. Amounts are calculated by translating prior period results using the same local currency rates as the comparable current period.

Net premiums written reflect the premiums we retain after purchasing reinsurance protection. Net premiums written increased for the three months ended June 30, 2014 in our Insurance – Overseas General segment on a constant-dollar basis from new business writings in all product lines – A&H, personal lines, and P&C. In addition, the acquisitions of ABA Seguros in May 2013 and Samaggi in April 2014 added to premium growth. The impact of foreign exchange adversely impacted growth on an as reported basis. Our Insurance – North American P&C segment also reported increases in net premiums written in our retail division from growth across a broad range of our product portfolio including our risk management business, surety, professional, general and specialty casualty, and A&H lines of business reflecting higher production and strong renewal retention. In addition, we grew net premiums written in our Commercial Risk Services division, primarily specialty and program business, and our personal lines division, primarily in the homeowners and automobile business offered through ACE Private Risk Services. Our wholesale and specialty division contributed to the increase in net premiums written from higher production in our property, casualty, and professional lines of business. Our Insurance – North American Agriculture segment reported a decrease in net premiums written primarily due to lower Multiple Peril Crop Insurance (MPCI) production reflecting lower commodity prices, partially offset by higher premium retention primarily as a result of the non-renewal of a third-party proportional reinsurance agreement.

For the six months ended June 30, 2014, net premiums written increased in our Insurance – Overseas General and Insurance – North American P&C segments due primarily to the factors described above. The acquisition of Fianzas Monterrey in April 2013 also added to premium growth in our Insurance – Overseas General segment. In addition, net premiums written increased in our Insurance – North American Agriculture segment, primarily due to decreased premium cessions to the U.S. government and to third-party reinsurers.

Net premiums earned for short-duration contracts, typically P&C contracts, generally reflect the portion of net premiums written that were recorded as revenues for the period as the exposure periods expire.  Net premiums earned for long-duration contracts,


48

typically traditional life contracts, generally are recognized as earned when due from policyholders. Net premiums earned increased for the three and six months ended June 30, 2014 primarily due to the increase in net premiums written as described above.

In evaluating our segments excluding Life, we use the combined ratio, the loss and loss expense ratio, the policy acquisition cost ratio, and the administrative expense ratio. We calculate these ratios by dividing the respective expense amounts by net premiums earned. We do not calculate these ratios for the Life segment as we do not use these measures to monitor or manage that segment. The combined ratio is determined by adding the loss and loss expense ratio, the policy acquisition cost ratio, and the administrative expense ratio. A combined ratio under 100 percent indicates underwriting income, and a combined ratio exceeding 100 percent indicates underwriting loss.

The following table presents our consolidated loss and loss expense ratio, policy acquisition cost ratio, administrative expense ratio, and combined ratio: 
 
Three Months Ended
 
 
Six Months Ended
 
 
June 30
 
 
June 30
 
 
2014

 
2013

 
2014

 
2013

Loss and loss expense ratio
58.4
%
 
58.7
%
 
58.0
%
 
58.0
%
Policy acquisition cost ratio
16.6
%
 
15.9
%
 
17.1
%
 
16.5
%
Administrative expense ratio
12.7
%
 
13.3
%
 
13.1
%
 
13.6
%
Combined ratio
87.7
%
 
87.9
%
 
88.2
%
 
88.1
%

The following table presents the impact of catastrophe losses and related reinstatement premiums and the impact of prior period reserve development on our consolidated loss and loss expense ratio: 
 
Three Months Ended
 
 
Six Months Ended
 
 
June 30
 
 
June 30
 
 
2014

 
2013

 
2014

 
2013

Loss and loss expense ratio, as reported
58.4
 %
 
58.7
 %
 
58.0
 %
 
58.0
 %
Catastrophe losses and related reinstatement premiums
(2.1
)%
 
(2.3
)%
 
(1.8
)%
 
(1.7
)%
Prior period development
3.3
 %
 
3.6
 %
 
2.4
 %
 
3.0
 %
Loss and loss expense ratio, adjusted
59.6
 %
 
60.0
 %
 
58.6
 %
 
59.3
 %
Total net pre-tax catastrophe losses, excluding related reinstatement premiums, were $80 million and $133 million for the three and six months ended June 30, 2014, compared with $81 million and $113 million in the prior year periods, respectively. Catastrophe losses through June 30, 2014 were primarily related to severe weather-related events in the U.S., Japan, and Australia, and flooding and hailstorms in Europe. Catastrophe losses in the prior year periods were primarily related to flooding in Canada and Australia and severe storms in the U.S. The adjusted loss and loss expense ratio decreased for the three and six months ended June 30, 2014 primarily due to both mix of business and underwriting actions improving loss ratios on several portfolios.
Prior period development arises from changes to loss estimates recognized in the current year that relate to loss events that occurred in previous calendar years and excludes the effect of losses from the development of earned premium from previous accident years. We experienced net favorable prior period development of $126 million and $188 million for the three and six months ended June 30, 2014, respectively. This compares with net favorable prior period development of $128 million and $198 million in the prior year periods, respectively. Refer to “Prior Period Development” for additional information.

Net investment income for the three and six months ended June 30, 2014 was $556 million and $1.1 billion compared with $534 million and $1.1 billion for the prior year periods, respectively. Refer to “Net Investment Income” and “Investments” for additional information.

Policy acquisition costs consist of commissions, premium taxes, and certain underwriting costs related directly to the successful acquisition of a new or renewal insurance contract. Our policy acquisition cost ratio increased for the three and six months ended June 30, 2014 primarily due to a change in the mix of business to products and regions that have a higher acquisition ratio.


49


Our administrative expense ratio decreased for the three months ended June 30, 2014 primarily due to growth in net premiums earned that outpaced the growth in administrative expenses, and the impact of the acquisitions described above, which include lower administrative expenses than our other businesses. In addition, the prior year included an expense adjustment that unfavorably impacted the prior year administrative expense ratio. A similar adjustment did not occur in the current year.

Our administrative expense ratio decreased for the six months ended June 30, 2014 primarily due to growth in net premiums earned that outpaced the growth in administrative expenses, and the impact of the acquisitions described above. In addition, the prior year included expense adjustments that unfavorably impacted the prior year administrative expense ratio, which were offset by the favorable impact of a prior year legal settlement.

Our effective income tax rate, which we calculate as income tax expense divided by income before income tax, is dependent upon the mix of earnings from different jurisdictions with various tax rates. A change in the geographic mix of earnings would change the effective income tax rate. Our effective income tax rate was 14.6 percent and 13.0 percent for the three and six months ended June 30, 2014, respectively. Our effective income tax rate was 11.5 percent and 11.4 percent for the three and six months ended June 30, 2013, respectively. The increase in effective tax rate was primarily due to both net realized losses and a lower percentage of operating earnings being generated in lower tax paying jurisdictions.

Prior Period Development
The following tables summarize (favorable) and adverse prior period development (PPD) by segment. Long-tail lines include lines such as workers' compensation, general liability, and professional liability; while short-tail lines include lines such as most property lines, energy, personal accident, aviation, marine (including associated liability-related exposures) and agriculture. Significant prior period movements by segment, principally driven by reserve reviews completed during each respective period, are discussed in more detail below. The remaining net development for long-tail and short-tail business for each segment comprises numerous favorable and adverse movements across a number of lines and accident years, none of which is significant individually or in the aggregate.
Three Months Ended June 30
Long-tail    

 
Short-tail

 
Total

 
% of net
unpaid
reserves(1)

(in millions of U.S. dollars, except for percentages)
 
 
 
2014
 
 
 
 
 
 
 
Insurance – North American P&C
$
(19
)
 
$
(20
)
 
$
(39
)
 
0.2
%
Insurance – North American Agriculture
—

 
—

 
—

 
—

Insurance – Overseas General
3

 
(66
)
 
(63
)
 
0.8
%
Global Reinsurance
(24
)
 
—

 
(24
)
 
1.2
%
Total
$
(40
)
 
$
(86
)
 
$
(126
)
 
0.5
%
2013
 
 
 
 
 
 
 
Insurance – North American P&C
$
(19
)
 
$
(28
)
 
$
(47
)
 
0.3
%
Insurance – North American Agriculture
—

 
—

 
—

 
—

Insurance – Overseas General
1

 
(53
)
 
(52
)
 
0.7
%
Global Reinsurance
(27
)
 
(2
)
 
(29
)
 
1.3
%
Total
$
(45
)
 
$
(83
)
 
$
(128
)
 
0.5
%
 
 
 
 
 
 
 
 
(1) Calculated based on the segment's total beginning of period net unpaid loss and loss expenses reserves.


50

Six Months Ended June 30
Long-tail    

 
Short-tail

 
Total

 
% of net
unpaid
reserves(1)

(in millions of U.S. dollars, except for percentages)
 
 
 
2014
 
 
 
 
 
 
 
Insurance – North American P&C
$
(80
)
 
$
(27
)
 
$
(107
)
 
0.7
%
Insurance – North American Agriculture
—

 
38

 
38

 
7.5
%
Insurance – Overseas General
4

 
(90
)
 
(86
)
 
1.0
%
Global Reinsurance
(23
)
 
(10
)
 
(33
)
 
1.5
%
Total
$
(99
)
 
$
(89
)
 
$
(188
)
 
0.7
%
2013
 
 
 
 
 
 
 
Insurance – North American P&C
$
(48
)
 
$
(39
)
 
$
(87
)
 
0.5
%
Insurance – North American Agriculture
—

 
(3
)
 
(3
)
 
0.9
%
Insurance – Overseas General
1

 
(75
)
 
(74
)
 
0.9
%
Global Reinsurance
(29
)
 
(5
)
 
(34
)
 
1.5
%
Total
$
(76
)
 
$
(122
)
 
$
(198
)
 
0.7
%
 
 
 
 
 
 
 
 
(1) Calculated based on the segment's total beginning of period net unpaid loss and loss expenses reserves.

Insurance – North American P&C
2014
For the three months ended June 30, 2014, net favorable PPD was $39 million, which was the net result of several underlying favorable and adverse movements, driven by the following principal changes:

•
Net favorable development of $19 million in long-tail business, primarily from:

•
Net favorable development of $33 million in our workers' compensation lines primarily in the 2013 accident year related to our annual assessment of multi-claimant events including industrial accidents. Consistent with prior years, we reviewed these potential exposures after the close of the accident year to allow for late reporting or identification of significant losses;

•
Net favorable development of $21 million in our auto liability excess lines primarily impacting the 2009 accident year. Reported activity on loss and allocated loss expenses was lower than expected based on estimates from our prior review and original pricing assumptions; and

•
Net adverse development of $28 million in our Brandywine run-off portfolios, primarily in general and products liability lines, including unallocated loss adjustment expenses, impacting the 1996 and prior accident years. Loss activity was higher than expected in these portfolios.
  
•
Net favorable development of $20 million in short-tail business, with the notable driver being net favorable development of $14 million on wholesale property, primarily impacting the 2012 and 2013 accident years. Paid and reported loss activity was favorable relative to prior expectations, especially in our primary business, and in the development of losses arising from natural catastrophes.

For the six months ended June 30, 2014, net favorable PPD was $107 million, which was the net result of several underlying favorable and adverse movements, driven by the following principal changes:

•
Net favorable development of $80 million in long-tail business, primarily from:

•
Favorable development of $67 million in our excess casualty and umbrella businesses. Resolution of a disputed matter on an individual claim led to a release of $42 million in the 2003 accident year, and lower than expected reported activity across a number of years drove the remaining improvement;

•
Favorable development of $26 million in our surety business, primarily from favorable claim emergence in the 2012 accident year;


51


•
Net favorable development of $21 million in our auto liability excess lines primarily impacting the 2009 accident year due to the same factors experienced for the three months ended June 30, 2014 as described above; and

•
Net adverse development of $36 million in our Brandywine run-off portfolios, primarily in general and products liability lines, including unallocated loss adjustment expenses, impacting the 1996 and prior accident years due to the same factors experienced for the three months ended June 30, 2014 as described above.

•
Net favorable development of $27 million in short-tail business driven by net favorable development of $14 million on wholesale property, primarily impacting the 2012 and 2013 accident years, due to the same factors experienced for the three months ended June 30, 2014 as described above.

2013
For the three months ended June 30, 2013, net favorable PPD was $47 million, which was the net result of several underlying favorable and adverse movements, driven by the following principal changes:

•
Net favorable development of $19 million in long-tail business, primarily from:

•
Net favorable development of $28 million in our national accounts portfolios which consist of commercial auto, general liability and workers' compensation lines of business. This favorable movement was the net impact of favorable and adverse movements, including:

•
Favorable development of $40 million related to our annual assessment of multi-claimant events including industrial accidents impacting the 2012 accident year. Consistent with prior years, we reviewed these potential exposures after the close of the accident year to allow for late reporting or identification of significant losses;

•
Net favorable development of $28 million on excess and high deductible workers' compensation lines driven by lower levels of reported losses than anticipated in our prior review and original pricing assumptions; and

•
Adverse development of $40 million predominantly in workers' compensation related product lines primarily impacting the 2006 and prior accident years. The development was a function of higher than expected reported loss activity, higher allocated loss adjustment expenses, as well as increased weighting applied to experience-based methods.

•
Net adverse development of $24 million in our Brandywine run-off portfolios primarily in general liability and workers' compensation product lines, including unallocated loss adjustment expenses, impacting the 1996 and prior accident years. Loss activity was higher than expected in these portfolios.

•
Net favorable development of $28 million in short-tail business, which was the net result of several underlying favorable and adverse movements, none of which was significant individually or in the aggregate.

For the six months ended June 30, 2013, net favorable PPD was $87 million, which was the net result of several underlying favorable and adverse movements, driven by the following principal changes:

•
Net favorable development of $48 million in long-tail business, primarily from:

•
Favorable development of $50 million in our U.S. excess casualty and umbrella businesses primarily impacting the 2007 and prior accident years. Reported activity on loss and allocated loss expenses was lower than expected based on estimates from our prior review. In addition, increased weighting was applied to experience-based methods;

•
Net favorable development of $28 million in our national accounts portfolios, which consist of commercial auto, general liability and workers' compensation lines of business, due to the same factors experienced for the three months ended June 30, 2013 as described above.

•
Net adverse development of $24 million in our Brandywine run-off portfolios' general liability and workers' compensation product lines, including unallocated loss adjustment expenses, impacting the 1996 and prior accident years due to the same factors experienced for the three months ended June 30, 2013 as described above.


52


•
Favorable development of $22 million in our surety business primarily impacting the 2011 accident year. Reported claims to date in the 2011 accident year were lower than historical averages which in turn has generated lower than expected reported loss activity; and

•
Adverse development of $23 million in our construction business impacting the 2012 and prior accident years. The adverse development was realized in both our workers' compensation and general liability product lines where loss activity in the period since our prior review was higher than expected.

•
Net favorable development of $39 million in short-tail business, which was the net result of several underlying favorable and adverse movements, none of which was significant individually or in the aggregate.

Insurance – North American Agriculture
Insurance – North American Agriculture experienced no PPD in both the three months ended June 30, 2014 and 2013.

For the six months ended June 30, 2014, adverse PPD was $38 million compared with favorable PPD of $3 million for the prior year period. Actual claim development in the first quarter of 2014 for the Multiple Peril Crop Insurance (MPCI) business was higher than our year-end 2013 expectations for the 2013 crop year.

Insurance – Overseas General
2014
For the three months ended June 30, 2014 net favorable PPD was $63 million which was the net result of several underlying favorable and adverse movements, driven by the following principal change:

•
Favorable development of $66 million in short-tail business, primarily from the property (excluding technical lines) and marine lines. Favorable large loss experience in accident year 2013 led to a $36 million reduction. Favorable development on specific claims and additional credibility assigned to accident years 2012 and prior favorable indications led to a $28 million reduction.

For the six months ended June 30, 2014 net favorable PPD was $86 million due primarily to the same factors experienced for the three months ended June 30, 2014 as described above.

2013
For the three months ended June 30, 2013 net favorable PPD was $52 million, which was the net result of several underlying favorable and adverse movements, driven by the following principal change:

•
Favorable development of $53 million in short-tail business, primarily from property and marine lines. Accident year 2009 through 2012 had favorable development of $38 million with no significant movement in any particular line or year. Accident years 2007 and prior had favorable development of $15 million mainly from specific litigated claims.

For the six months ended June 30, 2013 net favorable PPD was $74 million due to the same factors experienced for the three months ended June 30, 2013 as described above.

Global Reinsurance
2014
For the three and six months ended June 30, 2014, net favorable PPD were $24 million and $33 million, respectively, which were the net result of several underlying favorable and adverse movements across a number of lines and across a number of treaty years, none of which was significant individually or in the aggregate.

2013
For the three months ended June 30, 2013, net favorable PPD was $29 million which was the net result of several underlying favorable and adverse movements, driven by the following principal changes:

•
Favorable development of $27 million in long-tail business, primarily in the casualty line of business principally in treaty years 2007 and prior and in the professional liability line of business principally in treaty years 2008 and prior. Following the reserve studies completed in the three months ended June 30, 2013, we increased weighting applied to experience-


53

based methods. Since experience has tended to be generally favorable compared with assumptions, the changes resulted in the favorable development referenced above.

For the six months ended June 30, 2013, net favorable PPD was $34 million, which was the net result of several underlying favorable and adverse movements, primarily due to the same factors experienced for the three months ended June 30, 2013 as described above.

__________________________________________________________________________________________________________
Segment Operating Results – Three and Six Months Ended June 30, 2014 and 2013
We operate through five business segments: Insurance – North American P&C, Insurance – North American Agriculture, Insurance – Overseas General, Global Reinsurance, and Life. For additional information on our segments refer to “Segment Information” in our 2013 Form 10-K under Item 1. The discussions that follow include tables that show our segment operating results for the three and six months ended June 30, 2014 and 2013.

Insurance – North American

Insurance – North American P&C
The Insurance – North American P&C segment comprises our operations in the U.S., Canada, and Bermuda. This segment includes our retail divisions: ACE USA (including ACE Canada), ACE Commercial Risk Services, and ACE Private Risk Services; our wholesale and specialty divisions of ACE Westchester and ACE Bermuda; and various run-off operations, including Brandywine Holdings Corporation (Brandywine). 
 
Three Months Ended
 
 
 
 
Six Months Ended
 
 
 
 
June 30
 
 
% Change

 
June 30
 
 
% Change

(in millions of U.S. dollars, except for percentages)
2014

 
2013

 
Q-14 vs.
Q-13

 
2014

 
2013

 
YTD-14 vs.
YTD-13

Net premiums written
$
1,635

 
$
1,529

 
6.9
 %
 
$
3,053

 
$
2,813

 
8.5
 %
Net premiums earned
1,542

 
1,428

 
7.9
 %
 
3,029

 
2,766

 
9.5
 %
Losses and loss expenses
1,016

 
950

 
6.9
 %
 
1,956

 
1,828

 
7.0
 %
Policy acquisition costs
152

 
142

 
7.0
 %
 
311

 
285

 
9.1
 %
Administrative expenses
175

 
159

 
10.1
 %
 
336

 
284

 
18.3
 %
Underwriting income
199

 
177

 
12.4
 %
 
426

 
369

 
15.4
 %
Net investment income
265

 
250

 
6.0
 %
 
535

 
501

 
6.8
 %
Net realized gains (losses)
(11
)
 
28

 
NM

 
(20
)
 
54

 
NM

Interest expense
2

 
3

 
(33.3
)%
 
5

 
1

 
400.0
 %
Other (income) expense
(24
)
 
(10
)
 
140.0
 %
 
(44
)
 
(25
)
 
76.0
 %
Income tax expense
91

 
91

 
—

 
174

 
185

 
(5.9
)%
Net income
$
384

 
$
371

 
3.5
 %
 
$
806

 
$
763

 
5.6
 %
Loss and loss expense ratio
66.0
%
 
66.6
%
 
 
 
64.6
%
 
66.1
%
 
 
Policy acquisition cost ratio
9.8
%
 
9.9
%
 
 
 
10.3
%
 
10.3
%
 
 
Administrative expense ratio
11.3
%
 
11.1
%
 
 
 
11.0
%
 
10.3
%
 
 
Combined ratio
87.1
%
 
87.6
%
 
 
 
85.9
%
 
86.7
%
 
 

Net premiums written increased for the three and six months ended June 30, 2014 in our retail division from growth across a broad range of our product portfolio including our risk management business, surety, professional, general and specialty casualty, and A&H lines of business reflecting higher production and strong renewal retention. In addition, we grew net premiums written for the three and six months ended June 30, 2014 in our Commercial Risk Services division, primarily specialty and program business, and our personal lines division, primarily in the homeowners and automobile business offered through ACE Private Risk Services. Our wholesale and specialty divisions contributed to the increase in net premiums written for the three and six months ended June 30, 2014 from higher production in our property, casualty, and professional lines of business. In addition, net premiums written increased for the three and six months ended June 30, 2014 due to lower excess of loss premiums ceded under our 2014 catastrophe reinsurance program.


54

Net premiums earned increased for the three and six months ended June 30, 2014 primarily due to the increase in net premiums written as described above.
The following tables present a line of business breakdown of Insurance – North American P&C net premiums earned:
 
Three Months Ended
 
 
 
 
Six Months Ended
 
 
 
 
June 30
 
 
% Change

 
June 30
 
 
% Change

(in millions of U.S. dollars, except for percentages)
2014

 
2013

 
Q-14 vs.
Q-13

 
2014

 
2013

 
YTD-14 vs.
YTD-13

Commercial P&C (retail and wholesale)
$
1,215

 
$
1,132

 
7.3
%
 
$
2,385

 
$
2,192

 
8.8
%
Personal and small commercial lines
226

 
203

 
11.4
%
 
442

 
392

 
12.8
%
Personal accident (A&H)
101

 
93

 
7.8
%
 
202

 
182

 
10.2
%
Net premiums earned
$
1,542

 
$
1,428

 
7.9
%
 
$
3,029

 
$
2,766

 
9.5
%
 
 
 
 
 
 
 
 
 
 
 
 
 
2014
% of Total

 
2013
% of Total

 
 

 
2014
% of Total

 
2013
% of Total

 
 

Commercial P&C (retail and wholesale)
79
%
 
79
%
 
 
 
78
%
 
79
%
 
 
Personal and small commercial lines
15
%
 
15
%
 
 
 
15
%
 
14
%
 
 
Personal accident (A&H)
6
%
 
6
%
 
 
 
7
%
 
7
%
 
 
Net premiums earned
100
%
 
100
%
 
 
 
100
%
 
100
%
 
 
The following table presents the impact of catastrophe losses and related reinstatement premiums and prior period reserve development on our loss and loss expense ratio:
 
Three Months Ended
 
 
Six Months Ended
 
 
June 30
 
 
June 30
 
 
2014

 
2013

 
2014

 
2013

Loss and loss expense ratio, as reported
66.0
 %
 
66.6
 %
 
64.6
 %
 
66.1
 %
Catastrophe losses and related reinstatement premiums
(2.4
)%
 
(3.5
)%
 
(2.3
)%
 
(2.2
)%
Prior period development
2.6
 %
 
3.4
 %
 
3.6
 %
 
3.2
 %
Loss and loss expense ratio, adjusted
66.2
 %
 
66.5
 %
 
65.9
 %
 
67.1
 %
Net pre-tax catastrophe losses, excluding reinstatement premiums, were $36 million and $68 million for the three and six months ended June 30, 2014, compared with $50 million and $61 million in the prior year periods, respectively. Catastrophe losses through June 30, 2014 were primarily from severe weather-related events in the U.S. and Australia. Catastrophe losses through June 30, 2013 were primarily from flooding in Canada and severe weather-related events in the U.S. Net favorable prior period development was $39 million and $107 million for the three and six months ended June 30, 2014, compared with $47 million and $87 million in the prior year periods, respectively. Refer to “Prior Period Development” for additional information. For the three and six months ended June 30, 2014, the adjusted loss and loss expense ratio declined due to lower loss ratios in several of our lines where a combination of the execution of detailed portfolio management plans, product mix and earned rate changes have resulted in improved current accident year loss ratio performance. The improvement also reflects a reduction in loss adjustment expenses due to a change in estimated claim handling costs. These reductions were partially offset by higher non-catastrophe large losses in the current year quarter.
The policy acquisition cost ratio decreased slightly for the quarter and remained flat for the six months ended June 30, 2014.

The administrative expense ratio was higher for the three months ended June 30, 2014 due primarily to a non-recurring expense adjustment which unfavorably impacted the current year ratio. Excluding this adjustment, the administrative expense ratio decreased by 0.1 points. For the six months ended June 30, 2014, the administrative expense ratio was higher compared to the prior year ratio which included a 1.0 point favorable impact related to a $29 million legal settlement. Excluding the impact of the legal settlement and the second quarter expense adjustment, the administrative expense ratio decreased for the six-month period by 0.4 points due to growth in net premiums earned that outpaced the growth in administrative expenses.



55

Insurance – North American Agriculture
The Insurance – North American Agriculture segment comprises our North American based businesses that provide a variety of coverages in the U.S. and Canada including crop insurance, primarily MPCI and crop-hail through Rain and Hail as well as farm and ranch and specialty P&C commercial insurance products and services through our ACE Agribusiness unit.
 
 
Three Months Ended
 
 
 
 
Six Months Ended
 
 
 
 
June 30
 
 
% Change

 
June 30
 
 
% Change

(in millions of U.S. dollars, except for percentages)
2014

 
2013

 
Q-14 vs.
Q-13

 
2014

 
2013

 
YTD-14 vs.
YTD-13

Net premiums written
$
388

 
$
453

 
(14.2
)%
 
$
582

 
$
566

 
3.0
 %
Net premiums earned
330

 
351

 
(5.7
)%
 
433

 
403

 
7.6
 %
Losses and loss expenses (1)
279

 
293

 
(4.8
)%
 
407

 
325

 
25.2
 %
Policy acquisition costs
23

 
20

 
15.0
 %
 
28

 
24

 
16.7
 %
Administrative expenses
1

 
3

 
(66.7
)%
 
2

 
8

 
(75.0
)%
Underwriting income (loss)
27

 
35

 
(22.9
)%
 
(4
)
 
46

 
NM

Net investment income
6

 
7

 
(14.3
)%
 
13

 
13

 
—

Net realized gains (losses) excluding gains (losses) from fair value changes on crop derivatives (1)
—

 
1

 
NM

 
—

 
1

 
NM

Other (income) expense
9

 
8

 
12.5
 %
 
17

 
16

 
6.3
 %
Income tax expense (benefit)
5

 
8

 
(37.5
)%
 
(2
)
 
10

 
NM

Net income (loss)
$
19

 
$
27

 
(29.6
)%
 
$
(6
)
 
$
34

 
NM

Loss and loss expense ratio
84.4
%
 
83.4
%
 
 
 
93.9
%
 
80.6
%
 
 
Policy acquisition cost ratio
7.0
%
 
5.6
%
 
 
 
6.4
%
 
5.8
%
 
 
Administrative expense ratio
0.4
%
 
0.9
%
 
 
 
0.6
%
 
2.2
%
 
 
Combined ratio
91.8
%
 
89.9
%
 
 
 
100.9
%
 
88.6
%
 
 
(1)
(Gains) losses from fair value changes on crop derivatives are reclassified from Net realized gains (losses) to Losses and loss expenses for purposes of presenting Insurance - North American Agriculture underwriting income. Refer to Note 7 and Note 10 to the consolidated financial statements for more information on these derivatives.
Net premiums written decreased for the three months ended June 30, 2014 principally due to lower MPCI production reflecting lower commodity prices partially offset by higher premium retention primarily as a result of the non-renewal of a third-party proportional reinsurance agreement. For the six months ended June 30, 2014, net premiums written increased as the decrease for the quarter was more than offset by lower premium cessions to the U.S. government for the 2013 crop year as a result of the government's crop insurance profit and loss calculation formula, which typically results in higher retained premiums when losses increase.
Net premiums earned decreased for the three months ended June 30, 2014 and increased for the six months ended June 30, 2014 primarily due to the factors described above.

The following table presents the impact of catastrophe losses and related reinstatement premiums and prior period reserve development on our loss and loss expense ratio:
 
Three Months Ended
 
 
Six Months Ended
 
 
June 30
 
 
June 30
 
 
2014

 
2013

 
2014

 
2013

Loss and loss expense ratio, as reported
84.4
 %
 
83.4
 %
 
93.9
 %
 
80.6
 %
Catastrophe losses and related reinstatement premiums
(2.6
)%
 
(0.8
)%
 
(2.2
)%
 
(0.7
)%
Prior period development
—

 
—

 
(10.5
)%
 
0.8
 %
Loss and loss expense ratio, adjusted
81.8
 %
 
82.6
 %
 
81.2
 %
 
80.7
 %



56

Net pre-tax catastrophe losses, excluding reinstatement premiums, were $9 million and $10 million for the three and six months ended June 30, 2014 and $3 million for both of the prior year periods, respectively. For the three and six months ended June 30, 2014, net unfavorable prior period development was nil and $38 million, respectively. For the six month period, the amount includes an increase in incurred losses of $39 million for higher than expected MPCI losses for the 2013 crop year, as well as $36 million of unfavorable MPCI losses offset by a favorable increase in net premiums earned related to the government's crop insurance profit and loss calculation formula. For the three and six months ended June 30, 2013, net favorable prior period development was nil and $3 million, respectively. Refer to “Prior Period Development” for additional information. The adjusted loss and loss expense ratio was lower for the three months ended June 30, 2014 due to the net impact of a decline in commodity prices that resulted in higher estimated losses on our crop policies that was more than offset by a decrease in losses from the fair value changes on our crop derivative. Despite the reduction in the adjusted loss and loss expense ratio for the three month period, the ratio for the six months ended June 30, 2014 increased reflecting lower loss adjustment expenses in the prior year period due to a change in estimated claim handling costs. A similar benefit did not occur in the current year.

The policy acquisition cost ratio increased for the three and six months ended June 30, 2014 primarily from lower ceded commission benefits on third-party reinsurance. For the six months ended June 30, 2014, lower agent profit commission accruals for the 2013 crop year partially offset this increase.

The administrative expense ratio decreased for the three and six months ended June 30, 2014 due to lower expenses incurred.

Insurance – Overseas General
The Insurance – Overseas General segment comprises ACE International, ACE Global Markets (AGM), and the international supplemental A&H business of Combined Insurance. ACE International comprises our retail commercial P&C, A&H, and personal lines businesses serving territories outside the U.S., Bermuda, and Canada. AGM comprises the segment's London-based wholesale insurance business for excess and surplus lines; this includes Lloyd’s of London Syndicate 2488. The reinsurance operations of AGM are included in the Global Reinsurance segment.
 
Three Months Ended
 
 
 
 
Six Months Ended
 
 
 
 
 
June 30
 
 
% Change

 
June 30
 
 
% Change

 
(in millions of U.S. dollars, except for percentages)
2014

 
2013

 
Q-14 vs.
Q-13

 
2014

 
2013

 
YTD-14 vs.
YTD-13

 
Net premiums written
$
1,760

 
$
1,630

 
8.0
 %
(1) 
$
3,531

 
$
3,250

 
8.7
 %
(1) 
Net premiums earned
1,709

 
1,563

 
9.4
 %
 
3,321

 
3,022

 
9.9
 %
 
Losses and loss expenses
830

 
768

 
8.1
 %
 
1,647

 
1,515

 
8.7
 %
 
Policy acquisition costs
402

 
360

 
11.7
 %
 
788

 
699

 
12.7
 %
 
Administrative expenses
256

 
251

 
2.0
 %
 
506

 
487

 
3.9
 %
 
Underwriting income
221

 
184

 
20.1
 %
 
380

 
321

 
18.4
 %
 
Net investment income
136

 
136

 
—

 
268

 
268

 
—

 
Net realized gains (losses)
14

 
8

 
75.0
 %
 
4

 
42

 
(90.5
)%
 
Interest expense
1

 
2

 
(50.0
)%
 
2

 
3

 
(33.3
)%
 
Other (income) expense
8

 
17

 
(52.9
)%
 
2

 
16

 
(87.5
)%
 
Income tax expense
55

 
50

 
10.0
 %
 
92

 
96

 
(4.2
)%
 
Net income
$
307

 
$
259

 
18.5
 %
 
$
556

 
$
516

 
7.8
 %
 
Loss and loss expense ratio
48.6
%
 
49.1
%
 
 
 
49.6
%
 
50.1
%
 
 
 
Policy acquisition cost ratio
23.5
%
 
23.0
%
 
 
 
23.7
%
 
23.1
%
 
 
 
Administrative expense ratio
15.0
%
 
16.1
%
 
 
 
15.3
%
 
16.2
%
 
 
 
Combined ratio
87.1
%
 
88.2
%
 
 
 
88.6
%
 
89.4
%
 
 
 
(1) For the three and six months ended June 30, 2014, net premiums written increased $143 million or 8.8% on a constant-dollar basis and $337 million or 10.5% on a constant-dollar basis, respectively. Amounts are calculated by translating prior period results using the same local currency rates as the comparable current period. 

Net premiums written increased for the three and six months ended June 30, 2014 on a constant-dollar basis from new business writings in our retail operations in all product lines – A&H, personal lines, and P&C. A&H growth was driven by strong


57

results in all regions except Europe, and the increase in personal lines reflected growth in all regions, except Japan. P&C growth was driven primarily by new business writings in Asia and Europe and the acquisitions of ABA Seguros in May 2013 and Samaggi in April 2014. Growth for the six months ended June 30, 2014 also included the impact of Fianzas Monterrey, acquired in April 2013. The impact of foreign exchange adversely impacted growth in both periods on an as reported basis.
Net premiums earned increased for the three and six months ended June 30, 2014 primarily due to the increase in net premiums written as described above.
Insurance – Overseas General conducts business internationally and in most major foreign currencies. The following tables present a line of business and regional breakdown of Insurance – Overseas General net premiums earned:
 
Three Months Ended June 30
 
% Change
(in millions of U.S. dollars, except for percentages)
2014

 
2014
% of Total

 
2013

 
2013
% of Total

 
C$(1)
2013

 
Q-14 vs.
Q-13

 
C$(1)
Q-14 vs.
Q-13

Line of Business
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial P&C (retail and wholesale)
$
798

 
47
%
 
$
775

 
50
%
 
$
790

 
3.0
%
 
1.0
 %
Personal and small commercial lines
324

 
19
%
 
257

 
16
%
 
242

 
26.2
%
 
33.8
 %
Personal accident (A&H)
587

 
34
%
 
531

 
34
%
 
526

 
10.6
%
 
11.7
 %
Net premiums earned
$
1,709

 
100
%
 
$
1,563

 
100
%
 
$
1,558

 
9.4
%
 
9.8
 %
Region
 
 
 
 
 
 
 
 
 
 
 
 
 
Europe / U.K.
$
801

 
47
%
 
$
740

 
48
%
 
$
834

 
8.2
%
 
(4.0
)%
Asia Pacific
389

 
23
%
 
350

 
22
%
 
282

 
11.1
%
 
37.9
 %
Far East
107

 
6
%
 
107

 
7
%
 
104

 
—

 
2.9
 %
Latin America
412

 
24
%
 
366

 
23
%
 
338

 
12.6
%
 
21.9
 %
Net premiums earned
$
1,709

 
100
%
 
$
1,563

 
100
%
 
$
1,558

 
9.4
%
 
9.8
 %

 
Six Months Ended June 30
 
% Change
(in millions of U.S. dollars, except for percentages)
2014

 
2014
% of Total

 
2013

 
2013
% of Total

 
C$(1)
2013

 
YTD-14 vs.
YTD-13

 
C$(1)YTD-14 vs.
YTD-13

Line of Business
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial P&C (retail and wholesale)
$
1,561

 
47
%
 
$
1,511

 
50
%
 
$
1,512

 
3.3
 %
 
3.2
 %
Personal and small commercial lines
623

 
19
%
 
445

 
15
%
 
414

 
40.1
 %
 
50.6
 %
Personal accident (A&H)
1,137

 
34
%
 
1,066

 
35
%
 
1,038

 
6.7
 %
 
9.6
 %
Net premiums earned
$
3,321

 
100
%
 
$
3,022

 
100
%
 
$
2,964

 
9.9
 %
 
12.1
 %
Region
 
 
 
 
 
 
 
 
 
 
 
 
 
Europe / U.K.
$
1,553

 
47
%
 
$
1,466

 
49
%
 
$
1,573

 
5.9
 %
 
(1.3
)%
Asia Pacific
738

 
22
%
 
692

 
23
%
 
600

 
6.6
 %
 
23.0
 %
Far East
214

 
6
%
 
224

 
7
%
 
205

 
(4.5
)%
 
4.4
 %
Latin America
816

 
25
%
 
640

 
21
%
 
586

 
27.5
 %
 
39.2
 %
Net premiums earned
$
3,321

 
100
%
 
$
3,022

 
100
%
 
$
2,964

 
9.9
 %
 
12.1
 %
(1) On a constant-dollar basis.  Amounts are calculated by translating prior period results using the same local currency rates as the comparable current period. 


58

The following table presents the impact of catastrophe losses and related reinstatement premiums and prior period reserve development on our loss and loss expense ratio: 
 
Three Months Ended
 
 
Six Months Ended
 
 
June 30
 
 
June 30
 
 
2014

 
2013

 
2014

 
2013

Loss and loss expense ratio, as reported
48.6
 %
 
49.1
 %
 
49.6
 %
 
50.1
 %
Catastrophe losses and related reinstatement premiums
(1.5
)%
 
(1.1
)%
 
(1.3
)%
 
(1.3
)%
Prior period development
3.7
 %
 
3.3
 %
 
2.6
 %
 
2.5
 %
Loss and loss expense ratio, adjusted
50.8
 %
 
51.3
 %
 
50.9
 %
 
51.3
 %

Net pre-tax catastrophe losses, excluding reinstatement premiums, were $26 million and $43 million for the three and six months ended June 30, 2014, compared with $17 million and $38 million in the prior year periods, respectively. Catastrophe losses through June 30, 2014 were primarily related to flooding in Europe and severe storms in Japan. Catastrophe losses through June 30, 2013 were primarily related to flooding in Australia and Canada. Net favorable prior period development was $63 million and $86 million for the three and six months ended June 30, 2014, compared with $52 million and $74 million in the prior year periods, respectively. Refer to “Prior Period Development” for additional information. The decrease in the adjusted loss and loss expense ratio for the three and six months ended June 30, 2014 was due primarily to both mix of business and underwriting actions improving loss ratios on several portfolios.

The policy acquisition cost ratio increased for the three months ended June 30, 2014 primarily due to a change in the overall mix of business towards A&H and personal lines products in regions that have higher acquisition cost ratios. For the six months ended June 30, 2014, the increase noted above was partially offset by the impact of the businesses acquired described above, which carry lower acquisition cost ratios than our other businesses, and the result of purchase accounting requirements. As a result of purchase accounting requirements, the unearned premiums at the date of purchase related to the businesses acquired are recognized over the remaining coverage period with no expense for the associated historical acquisition costs that were incurred to underwrite those policies.
The administrative expense ratio decreased for the three and six months ended June 30, 2014 due primarily to growth in net premiums earned that outpaced the growth in administrative expenses, and the acquisitions described above, which include lower administrative expenses than our other businesses.



59

Global Reinsurance

The Global Reinsurance segment represents our reinsurance operations comprising ACE Tempest Re Bermuda, ACE Tempest Re USA, ACE Tempest Re International, and ACE Tempest Re Canada. Global Reinsurance markets its reinsurance products worldwide under the ACE Tempest Re brand name and provides a broad range of coverage to a diverse array of primary P&C companies.
 
Three Months Ended
 
 
 
 
Six Months Ended
 
 
 
 
June 30
 
 
% Change

 
June 30
 
 
% Change

(in millions of U.S. dollars, except for percentages)
2014

 
2013

 
Q-14 vs.
Q-13

 
2014

 
2013

 
YTD-14 vs.
YTD-13

Net premiums written
$
278

 
$
292

 
(4.9
)%
 
$
586

 
$
571

 
2.5
 %
Net premiums earned
261

 
245

 
6.1
 %
 
545

 
492

 
10.8
 %
Losses and loss expenses
109

 
93

 
17.2
 %
 
235

 
199

 
18.1
 %
Policy acquisition costs
60

 
48

 
25.0
 %
 
127

 
96

 
32.3
 %
Administrative expenses
14

 
12

 
16.7
 %
 
28

 
24

 
16.7
 %
Underwriting income
78

 
92

 
(15.2
)%
 
155

 
173

 
(10.4
)%
Net investment income
80

 
71

 
12.7
 %
 
157

 
143

 
9.8
 %
Net realized gains (losses)
(15
)
 
31

 
NM

 
(23
)
 
51

 
NM

Interest expense
2

 
1

 
100.0
 %
 
3

 
2

 
50.0
 %
Other (income) expense
(10
)
 
2

 
NM

 
(29
)
 
(6
)
 
383.3
 %
Income tax expense
10

 
7

 
42.9
 %
 
20

 
15

 
33.3
 %
Net income
$
141

 
$
184

 
(23.4
)%
 
$
295

 
$
356

 
(17.1
)%
Loss and loss expense ratio
41.7
%
 
37.7
%
 
 
 
43.1
%
 
40.3
%
 
 
Policy acquisition cost ratio
23.1
%
 
19.9
%
 
 
 
23.3
%
 
19.6
%
 
 
Administrative expense ratio
5.1
%
 
4.6
%
 
 
 
5.1
%
 
4.9
%
 
 
Combined ratio
69.9
%
 
62.2
%
 
 
 
71.5
%
 
64.8
%
 
 

Net premiums written decreased for the three months ended June 30, 2014 primarily due to lower net property catastrophe premiums. For the six months ended June 30, 2014, this decrease was more than offset by increased net premiums written from a number of new large personal lines structured transactions (homeowners and automobile) in our U.S. operations.

Net premiums earned increased for the three and six months ended June 30, 2014 primarily in our U.S. property and casualty lines of business from higher premiums written in the current and prior year periods.
The following tables present a line of business breakdown of Global Reinsurance net premiums earned:
 
 
Three Months Ended
 
 
 
 
Six Months Ended
 
 
 
 
June 30
 
 
% Change

 
June 30
 
 
% Change

(in millions of U.S. dollars, except for percentages)
2014

 
2013

 
Q-14 vs.
Q-13

 
2014

 
2013

 
YTD -14 vs.
YTD -13

Property and all other
$
72

 
$
59

 
22.0
 %
 
$
156

 
$
119

 
31.1
 %
Casualty
129

 
113

 
14.2
 %
 
259

 
225

 
15.1
 %
Property catastrophe
60

 
73

 
(17.8
)%
 
130

 
148

 
(12.2
)%
Net premiums earned
$
261

 
$
245

 
6.1
 %
 
$
545

 
$
492

 
10.8
 %
 
 
 
 
 
 
 
 
 
 
 
 
 
2014
% of Total

 
2013
% of Total

 
 

 
2014
% of Total

 
2013
% of Total

 
 

Property and all other
28
%
 
24
%
 
 
 
29
%
 
24
%
 
 
Casualty
49
%
 
46
%
 
 
 
47
%
 
46
%
 
 
Property catastrophe
23
%
 
30
%
 
 
 
24
%
 
30
%
 
 
Net premiums earned
100
%
 
100
%
 
 
 
100
%
 
100
%
 
 



60

The following table presents the impact of catastrophe losses and related reinstatement premiums and prior period reserve development on our loss and loss expense ratio:
 
Three Months Ended
 
 
Six Months Ended
 
 
June 30
 
 
June 30
 
 
2014

 
2013

 
2014

 
2013

Loss and loss expense ratio, as reported
41.7
 %
 
37.7
 %
 
43.1
 %
 
40.3
 %
Catastrophe losses and related reinstatement premiums
(3.4
)%
 
(4.6
)%
 
(2.2
)%
 
(2.2
)%
Prior period development
8.9
 %
 
12.2
 %
 
5.9
 %
 
7.0
 %
Loss and loss expense ratio, adjusted
47.2
 %
 
45.3
 %
 
46.8
 %
 
45.1
 %
Net pre-tax catastrophe losses, excluding reinstatement premiums, were $9 million and $12 million for the three and six months ended June 30, 2014 and $11 million for both of the prior year periods, respectively. Catastrophe losses through June 30, 2014 were related to severe storms in Japan, European hailstorms and severe weather related events in the U.S. Catastrophe losses through June 30, 2013 were primarily related to flooding in Canada and Europe. Net favorable prior period development was $24 million and $33 million for the three and six months ended June 30, 2014, compared with $29 million and $34 million in the prior year periods, respectively. Refer to “Prior Period Development” for additional information. The adjusted loss and loss expense ratio increased for the three and six months ended June 30, 2014 primarily due to a change in the mix of business towards higher loss ratio products.

The policy acquisition cost ratio increased for the three and six months ended June 30, 2014 primarily due to a change in the mix of business towards products written in the U.S. that have a higher acquisition cost ratio than in other regions.

The administrative expense ratio increased for the three and six months ended June 30, 2014. The prior year included the favorable impact of a $2 million expense adjustment that reduced the administrative expense ratio in the prior year periods. Excluding this adjustment, the administrative expense ratio decreased for the three and six months ended June 30, 2014 due to the increase in net premiums earned.



61

Life
The Life segment includes our international life operations (ACE Life), ACE Tempest Life Re (ACE Life Re), and the North American supplemental A&H and life business of Combined Insurance. We assess the performance of our life business based on Life underwriting income, which includes Net investment income and (Gains) losses from fair value changes in separate account assets that do not qualify for separate account reporting under GAAP.
 
Three Months Ended
 
 
 
 
Six Months Ended
 
 
 
 
June 30
 
 
% Change

 
June 30
 
 
% Change

(in millions of U.S. dollars, except for percentages)
2014

 
2013

 
Q-14 vs.
Q-13

 
2014

 
2013

 
YTD-14 vs.
YTD-13

Net premiums written
$
498

 
$
487

 
2.2
 %
 
$
992

 
$
989

 
0.2
 %
Net premiums earned
490

 
480

 
2.2
 %
 
974

 
957

 
1.8
 %
Losses and loss expenses
146

 
145

 
0.7
 %
 
297

 
302

 
(1.7
)%
Policy benefits
144

 
110

 
30.9
 %
 
258

 
241

 
7.1
 %
(Gains) losses from fair value changes in separate account assets(1)
(17
)
 
11

 
NM

 
(11
)
 
7

 
NM

Policy acquisition costs
121

 
95

 
27.4
 %
 
232

 
175

 
32.6
 %
Administrative expenses
73

 
86

 
(15.1
)%
 
141

 
171

 
(17.5
)%
Net investment income
66

 
63

 
4.8
 %
 
130

 
126

 
3.2
 %
Life underwriting income
89

 
96

 
(7.3
)%
 
187

 
187

 
—

Net realized gains (losses)
(72
)
 
36

 
NM

 
(148
)
 
163

 
NM

Interest expense
3

 
4

 
(25.0
)%
 
6

 
8

 
(25.0
)%
Other (income) expense(1)
4

 
3

 
33.3%

 
11

 
3

 
266.7
 %
Income tax expense
12

 
10

 
20.0
 %
 
22

 
23

 
(4.3
)%
Net income (loss)
$
(2
)
 
$
115

 
NM

 
$
—

 
$
316

 
NM

(1)
(Gains) losses from fair value changes in separate account assets that do not qualify for separate account reporting under GAAP are reclassified from Other (income) expense for purposes of presenting Life underwriting income.
The following table presents a line of business breakdown of Life net premiums written and deposits collected on universal life and investment contracts: 
 
Three Months Ended
 
 
 
 
Six Months Ended
 
 
 
 
June 30
 
 
% Change

 
June 30
 
 
% Change

(in millions of U.S. dollars, except for percentages)
2014

 
2013

 
Q-14 vs.
Q-13

 
2014

 
2013

 
YTD-14 vs.
YTD-13

A&H
$
247

 
$
252

 
(2.0
)%
 
$
494

 
$
513

 
(3.7
)%
Life insurance
186

 
163

 
14.1
 %
 
366

 
330

 
10.9
 %
Life reinsurance
65

 
72

 
(9.7
)%
 
132

 
146

 
(9.6
)%
Net premiums written (excludes deposits below)
$
498

 
$
487

 
2.2
 %
 
$
992

 
$
989

 
0.2
 %
 
 
 
 
 
 
 
 
 
 
 
 
Deposits collected on universal life and investment contracts
$
282

 
$
222

 
27.0
 %
 
$
484

 
$
424

 
14.2
 %

A&H net premiums written decreased for the three and six months ended June 30, 2014 as growth in certain program business was more than offset by the non-renewal of several large accounts and a catch-up in premium registrations in the prior year periods. Life insurance net premiums written increased for the three and six months ended June 30, 2014 primarily due to growth in our Asian and Latin American markets. Life reinsurance net premiums written decreased for the three and six months ended June 30, 2014 because no new life reinsurance business is currently being written.
 
Deposits collected on universal life and investment contracts (life deposits) are not reflected as revenues in our consolidated statements of operations in accordance with GAAP. New life deposits are an important component of production and key to our efforts to grow our business. Although life deposits do not significantly affect current period income from operations, they are an


62

important indicator of future profitability. Life deposits collected for the three and six months ended June 30, 2014 increased compared to prior year due to growth in our Asian markets.

Net realized gains (losses), which are excluded from Life underwriting income, relate primarily to the change in the net fair value of reported GLB reinsurance liabilities and changes in the fair value of derivatives used to partially offset the risk in the variable annuity guarantee portfolio. During the quarter, realized gains of $2 million were associated with a net decrease in the value of GLB liabilities. During the six months ended June 30, 2014, realized losses of $48 million were associated with a net increase in the value of GLB liabilities. The increase in the value of GLB liabilities during the six months ended June 30, 2014, was primarily due to lower interest rates and the unfavorable impact of discounting future claims for two fewer quarters, partially offset by rising U.S. equity levels. In addition, we experienced realized losses of $72 million and $91 million for the three and six months ended June 30, 2014 due to a decrease in the value of the derivative instruments, which decrease in value when the S&P 500 index increases.
______________________________________________________________________________________________________________________
Other Income and Expense Items
 
Three Months Ended
 
 
Six Months Ended
 
 
June 30
 
 
June 30
 
(in millions of U. S. dollars)
2014

 
2013

 
2014

 
2013

Amortization of intangible assets
$
30

 
$
23

 
$
51

 
$
38

Equity in net (income) loss of partially-owned entities
(44
)
 
(14
)
 
(99
)
 
(49
)
(Gains) losses from fair value changes in separate account assets
(17
)
 
11

 
(11
)
 
7

Federal excise and capital taxes
5

 
6

 
9

 
11

Acquisition-related costs
2

 
2

 
6

 
2

Other
(1
)
 
9

 
2

 
18

Other (income) expense
$
(25
)
 
$
37

 
$
(42
)
 
$
27


Other (income) expense includes Amortization of intangible assets, which is higher in 2014 due primarily to our recent acquisitions. Refer to Note 2 to the Consolidated Financial Statements for additional information on our acquisitions. Equity in net (income) loss of partially-owned entities includes our share of net (income) loss related to investment funds, limited partnerships, partially-owned investment companies, and partially-owned insurance companies. Also included in Other (income) expense are (Gains) losses from fair value changes in separate account assets that do not qualify for separate account reporting under GAAP. The offsetting movement in the separate account liabilities is included in Policy benefits in the consolidated statements of operations. Certain federal excise and capital taxes incurred as a result of capital management initiatives are included in Other (income) expense as these are considered capital transactions and are excluded from underwriting results.

The following table presents, as of June 30, 2014, the estimated pre-tax amortization expense related to intangible assets for the third and fourth quarters of 2014 and the next five years:
For the Year Ending December 31
Amortization of intangible assets

(in millions of U.S. dollars)
Third and fourth quarters of 2014
$
52

2015
80

2016
66

2017
60

2018
57

2019
54

Total
$
369




63

______________________________________________________________________________________________________________________
Net Investment Income
 
Three Months Ended
 
 
Six Months Ended
 
 
June 30
 
 
June 30
 
(in millions of U.S. dollars)
2014

 
2013

 
2014

 
2013

Fixed maturities
$
541

 
$
518

 
$
1,085

 
$
1,034

Short-term investments
10

 
7

 
18

 
13

Equity securities
10

 
12

 
19

 
20

Other investments
27

 
26

 
47

 
57

Gross investment income
588

 
563

 
1,169

 
1,124

Investment expenses
(32
)
 
(29
)
 
(60
)
 
(59
)
Net investment income
$
556

 
$
534

 
$
1,109

 
$
1,065


Net investment income is influenced by a number of factors including the amounts and timing of inward and outward cash flows, the level of interest rates, and changes in overall asset allocation. Net investment income increased 4.2 percent and 4.1 percent for the three and six months ended June 30, 2014, respectively, compared with the prior year periods. The increase in net investment income was primarily due to a higher invested asset base.

The investment portfolio’s average market yield on fixed maturities was 2.6 percent and 2.9 percent at June 30, 2014 and 2013, respectively. Average market yield on fixed maturities represents the weighted average yield to maturity of our fixed income portfolio based on the market prices of the holdings at that date.

The 1.8 percent and 1.7 percent yield on short-term investments for the three and six months ended June 30, 2014, respectively, reflect the global nature of our insurance operations. For example, yields on short-term investments in Mexico, Malaysia, Indonesia, China, and Ecuador range from 3.0 percent to 8.2 percent.

The 4.4 percent yield on our equity securities portfolio is high relative to the yield on the S&P 500 Index because of dividends on preferred equity securities and because we classify our strategic emerging debt portfolio, which is a mutual fund, as equity. The preferred equity securities and strategic emerging debt portfolio represented 68 percent and 70 percent of the gross equity securities investment income for the three and six months ended June 30, 2014, respectively.

______________________________________________________________________________________________________________________
Net Realized and Unrealized Gains (Losses)

We take a long-term view with our investment strategy, and our investment managers manage our investment portfolio to maximize total return within certain specific guidelines designed to minimize risk. The majority of our investment portfolio is available for sale and reported at fair value. Our held to maturity investment portfolio is reported at amortized cost.

The effect of market movements on our available for sale investment portfolio impacts Net income (through Net realized gains (losses)) when securities are sold or when we record an Other-than-temporary impairment (OTTI) charge in Net income. For a discussion related to how we assess OTTI for all of our investments, including credit-related OTTI, and the related impact on Net income, refer to Note 3 c) to the Consolidated Financial Statements. Additionally, Net income is impacted through the reporting of changes in the fair value of derivatives, including financial futures, options, swaps, and GLB reinsurance. Changes in unrealized appreciation and depreciation on available for sale securities, which result from the revaluation of securities held, are reported as a separate component of Accumulated other comprehensive income in Shareholders’ equity in the consolidated balance sheets.



64

The following tables present our pre-tax net realized and unrealized gains (losses) on investments:
 
Three Months Ended June 30, 2014
 
 
Three Months Ended June 30, 2013
 
(in millions of U.S. dollars)
Net
Realized
Gains
(Losses) (1)

 
Net
Unrealized
Gains
(Losses)

 
Net
Impact

 
Net
Realized
Gains
(Losses) (1)

 
Net
Unrealized
Gains
(Losses)

 
Net
Impact

Fixed maturities
$
20

 
$
538

 
$
558

 
$
31

 
$
(1,466
)
 
$
(1,435
)
Fixed income derivatives
(15
)
 
—

 
(15
)
 
40

 
—

 
40

Total fixed maturities
5

 
538

 
543

 
71

 
(1,466
)
 
(1,395
)
Public equity
1

 
24

 
25

 
7

 
(57
)
 
(50
)
Private equity
(3
)
 
6

 
3

 
(1
)
 
15

 
14

Other
(1
)
 
—

 
(1
)
 
—

 
—

 
—

Subtotal
2

 
568

 
570

 
77

 
(1,508
)
 
(1,431
)
Derivatives
 
 
 
 
 
 
 
 
 
 
 
Fair value adjustment on insurance derivatives
2

 
—

 
2

 
101

 
—

 
101

S&P put option and futures
(72
)
 
—

 
(72
)
 
(68
)
 
—

 
(68
)
Fair value adjustment on other derivatives
9

 
—

 
9

 
(1
)
 
—

 
(1
)
Subtotal derivatives
(61
)
 
—

 
(61
)
 
32

 
—

 
32

Foreign exchange losses
(14
)
 
—

 
(14
)
 
(5
)
 
—

 
(5
)
Total gains (losses)
$
(73
)
 
$
568

 
$
495

 
$
104

 
$
(1,508
)
 
$
(1,404
)
(1) 
For the three months ended June 30, 2014, other-than-temporary impairments include $8 million for fixed maturities, $3 million for private equity, and $1 million for public equity. For the three months ended June 30, 2013, other-than-temporary impairments include $6 million for fixed maturities and $1 million for private equity.

 
Six Months Ended June 30, 2014
 
 
Six Months Ended June 30, 2013
 
(in millions of U.S. dollars)
Net
Realized
Gains
(Losses) (1)

 
Net
Unrealized
Gains
(Losses)

 
Net
Impact

 
Net
Realized
Gains
(Losses) (1)

 
Net
Unrealized
Gains
(Losses)

 
Net
Impact

Fixed maturities
$
31

 
$
999

 
$
1,030

 
$
67

 
$
(1,657
)
 
$
(1,590
)
Fixed income derivatives
(40
)
 
—

 
(40
)
 
58

 
—

 
58

Total fixed maturities
(9
)
 
999

 
990

 
125

 
(1,657
)
 
(1,532
)
Public equity
(4
)
 
34

 
30

 
6

 
(43
)
 
(37
)
Private equity
(3
)
 
48

 
45

 
(2
)
 
40

 
38

Other
(8
)
 
—

 
(8
)
 
—

 
1

 
1

Subtotal
(24
)
 
1,081

 
1,057

 
129

 
(1,659
)
 
(1,530
)
Derivatives
 
 
 
 
 
 
 
 
 
 
 
Fair value adjustment on insurance derivatives
(46
)
 
—

 
(46
)
 
429

 
—

 
429

S&P put option and futures
(91
)
 
—

 
(91
)
 
(318
)
 
—

 
(318
)
Fair value adjustment on other derivatives
7

 
—

 
7

 
(1
)
 
—

 
(1
)
Subtotal derivatives
(130
)
 
—

 
(130
)
 
110

 
—

 
110

Foreign exchange gains (losses)
(23
)
 
—

 
(23
)
 
71

 
—

 
71

Total gains (losses)
$
(177
)
 
$
1,081

 
$
904

 
$
310

 
$
(1,659
)
 
$
(1,349
)
(1) 
For the six months ended June 30, 2014, other-than-temporary impairments include $13 million for fixed maturities, $3 million for private equity, and $7 million for public equity. For the six months ended June 30, 2013, other-than-temporary impairments include $7 million for fixed maturities, $2 million for private equity, and $1 million for public equity.



65

At June 30, 2014, our investment portfolios held by U.S. legal entities included approximately $60 million of gross unrealized losses on fixed income investments. Our tax planning strategy related to these losses is based on our view that we will hold these fixed income investments until they recover their cost. As such, we have recognized a deferred tax asset of approximately $21 million related to these fixed income investments. This strategy allows us to recognize the associated deferred tax asset related to these fixed income investments as we do not believe these losses will ever be realized.

______________________________________________________________________________________________________________________
Investments
Our investment portfolio is invested primarily in publicly traded, investment grade, fixed income securities with an average credit quality of A/Aa as rated by the independent investment rating services Standard and Poor’s (S&P)/ Moody’s Investors Service (Moody’s). The portfolio is externally managed by independent, professional investment managers and is broadly diversified across geographies, sectors, and issuers. Other investments principally comprise direct investments, investment funds, and limited partnerships. We hold no collateralized debt obligations or collateralized loan obligations in our investment portfolio, and we provide no credit default protection. We have long-standing global credit limits for our entire portfolio across the organization. Exposures are aggregated, monitored, and actively managed by our Global Credit Committee, comprising senior executives, including our Chief Financial Officer, our Chief Risk Officer, our Chief Investment Officer, and our Treasurer. We also have well-established, strict contractual investment rules requiring managers to maintain highly diversified exposures to individual issuers and closely monitor investment manager compliance with portfolio guidelines.

The average duration of our fixed income securities, including the effect of options and swaps, was 4.0 years at both June 30, 2014 and December 31, 2013. We estimate that a 100 basis point (bps) increase in interest rates would reduce the valuation of our fixed income portfolio by approximately $2.4 billion at June 30, 2014.

The following table shows the fair value and cost/amortized cost of our invested assets:
 
June 30, 2014
 
 
December 31, 2013
 
(in millions of U.S. dollars)
Fair
Value

 
Cost/
Amortized
Cost

 
Fair
Value

 
Cost/
Amortized
Cost

Fixed maturities available for sale
$
51,601

 
$
49,719

 
$
49,254

 
$
48,406

Fixed maturities held to maturity
6,015

 
5,774

 
6,263

 
6,098

Short-term investments
2,108

 
2,108

 
1,763

 
1,763

 
59,724

 
57,601

 
57,280

 
56,267

Equity securities
907

 
874

 
837

 
841

Other investments
3,230

 
2,876

 
2,976

 
2,671

Total investments
$
63,861

 
$
61,351

 
$
61,093

 
$
59,779


The fair value of our total investments increased $2.8 billion during the six months ended June 30, 2014, primarily due to the investing of operating cash flows and unrealized appreciation.


66

The following tables present the market value of our fixed maturities and short-term investments at June 30, 2014 and December 31, 2013. The first table lists investments according to type and second according to S&P credit rating:
 
June 30, 2014
 
 
December 31, 2013
 
(in millions of U.S. dollars, except for percentages)
Market
Value

 
% of Total

 
Market
Value

 
% of Total

Treasury
$
2,386

 
4
%
 
$
2,327

 
4
%
Agency
1,278

 
2
%
 
1,454

 
3
%
Corporate and asset-backed securities
19,959

 
33
%
 
19,475

 
34
%
Mortgage-backed securities
12,659

 
21
%
 
12,273

 
21
%
Municipal
4,872

 
8
%
 
4,500

 
8
%
Non-U.S.
16,462

 
28
%
 
15,488

 
27
%
Short-term investments
2,108

 
4
%
 
1,763

 
3
%
Total
$
59,724

 
100
%
 
$
57,280

 
100
%
AAA
$
9,073

 
15
%
 
$
8,677

 
15
%
AA
22,470

 
38
%
 
21,520

 
38
%
A
11,400

 
19
%
 
11,168

 
19
%
BBB
7,996

 
13
%
 
7,193

 
12
%
BB
4,435

 
7
%
 
4,418

 
8
%
B
4,126

 
7
%
 
3,940

 
7
%
Other
224

 
1
%
 
364

 
1
%
Total
$
59,724

 
100
%
 
$
57,280

 
100
%

Corporate and asset-backed securities
The following table presents our 10 largest global exposures to corporate bonds by market value at June 30, 2014: 
(in millions of U.S. dollars)
Market Value

JP Morgan Chase & Co
$
481

General Electric Co
407

Goldman Sachs Group Inc
360

Wells Fargo & Co
291

Verizon Communications Inc
274

HSBC Holdings Plc
260

Morgan Stanley
256

Citigroup Inc
251

Bank of America Corp
239

AT&T INC
235


Mortgage-backed securities
 
S&P Credit Rating
 
 
Market
 Value

 
Amortized Cost

June 30, 2014 (in millions of U.S. dollars)
AAA

 
AA

 
A

 
BBB

 
BB and
below

 
Total

 
Total

Agency residential mortgage-backed (RMBS)
$
—

 
$
10,563

 
$
—

 
$
—

 
$
—

 
$
10,563

 
$
10,319

Non-agency RMBS
51

 
7

 
21

 
14

 
51

 
144

 
142

Commercial mortgage-backed
1,923

 
14

 
12

 
3

 
—

 
1,952

 
1,911

Total mortgage-backed securities
$
1,974

 
$
10,584

 
$
33

 
$
17

 
$
51

 
$
12,659

 
$
12,372



67


Municipal
As part of our overall investment strategy, we may invest in states, municipalities, and other political subdivisions fixed maturity securities (Municipal). We apply the same investment selection process described previously to our Municipal investments. The portfolio is highly diversified primarily in state general obligation bonds and essential service revenue bonds including education and utilities (water, power, and sewers).

Non-U.S.
Our exposure to the Euro results primarily from ACE European Group which is headquartered in London and offers a broad range of coverages throughout the European Union, Central, and Eastern Europe. ACE primarily invests in Euro denominated investments to support its local currency insurance obligations and required capital levels. ACE’s local currency investment portfolios have strict contractual investment guidelines requiring managers to maintain a high quality and diversified portfolio to both sector and individual issuers. Investment portfolios are monitored daily to ensure investment manager compliance with portfolio guidelines.

Our non-U.S. investment grade fixed income portfolios are currency-matched with the insurance liabilities of our non-U.S. operations. The average credit quality of our non-U.S. fixed income securities is A and 52 percent of our holdings are rated AAA or guaranteed by governments or quasi-government agencies. Within the context of these investment portfolios, our government and corporate bond holdings are highly diversified across industries and geographies. Issuer limits are based on credit rating (AA—two percent, A—one percent, BBB—0.5 percent of the total portfolio) and are monitored daily via an internal compliance system. Because of this investment approach we do not have a direct exposure to troubled sovereign borrowers in Europe. We manage our indirect exposure using the same credit rating based investment approach. Accordingly, we do not believe our indirect exposure is material.
The following table summarizes the market value and amortized cost of our non-U.S. fixed income portfolio by country/sovereign for non-U.S. government securities at June 30, 2014: 
(in millions of U.S. dollars)
Market Value

 
Amortized Cost

United Kingdom
$
1,123

 
$
1,130

Republic of Korea
812

 
760

Canada
560

 
548

United Mexican States
462

 
458

Kingdom of Thailand
377

 
373

Province of Ontario
359

 
347

Japan
302

 
302

Federative Republic of Germany
285

 
277

Province of Quebec
270

 
260

Federative Republic of Brazil
264

 
260

Other Non-U.S. Government Securities(1)
2,773

 
2,676

Total
$
7,587

 
$
7,391

(1) 
There are no investments in Portugal, Ireland, Italy, Greece or Spain.



68

The following table summarizes the market value and amortized cost of our non-U.S. fixed income portfolio by country/sovereign for non-U.S. corporate securities at June 30, 2014: 
(in millions of U.S. dollars)
Market Value

 
Amortized Cost

United Kingdom
$
1,588

 
$
1,507

Canada
1,150

 
1,087

Australia
663

 
638

United States
620

 
585

France
581

 
555

Netherlands
549

 
524

Germany
477

 
455

Switzerland
297

 
282

Euro Supranational
289

 
280

Brazil
235

 
229

Other Non-U.S. Corporate Securities
2,426

 
2,360

Total
$
8,875

 
$
8,502


The countries that are listed in the non-U.S. corporate fixed income portfolio above represent the ultimate parent company's country of risk. Non-U.S. corporate securities could be issued by foreign subsidiaries of U.S. corporations.

Below-investment grade corporate fixed income portfolio
Below-investment grade securities have different characteristics than investment grade corporate debt securities. Risk of loss from default by the borrower is greater with below-investment grade securities. Below-investment grade securities are generally unsecured and are often subordinated to other creditors of the issuer. Also, issuers of below-investment grade securities usually have higher levels of debt and are more sensitive to adverse economic conditions, such as recession or increasing interest rates, than are investment grade issuers. At June 30, 2014, our corporate fixed income investment portfolio included below-investment grade and non-rated securities which, in total, comprised approximately 14 percent of our fixed income portfolio. Our below-investment grade and non-rated portfolio includes over 1,200 issuers, with the greatest single exposure being $97 million.

We manage high-yield bonds as a distinct and separate asset class from investment grade bonds. The allocation to high-yield bonds is explicitly set by internal management and is targeted to securities in the upper tier of credit quality (BB/B). Our minimum rating for initial purchase is BB/B. Six external investment managers are responsible for high-yield security selection and portfolio construction. Our high-yield managers have a conservative approach to credit selection and very low historical default experience. Holdings are highly diversified across industries and subject to a 1.5 percent issuer limit as a percentage of high-yield allocation. We monitor position limits daily through an internal compliance system. Derivative and structured securities (e.g., credit default swaps and collateralized loan obligations) are not permitted in the high-yield portfolio.
____________________________________________________________________________________________________________
Critical Accounting Estimates
As of June 30, 2014, there were no material changes to our critical accounting estimates. For a full discussion of our critical accounting estimates, refer to Item 7 in our 2013 Form 10-K.

Reinsurance recoverable on ceded reinsurance
 
June 30

 
December 31

(in millions of U.S. dollars)
2014

 
2013

Reinsurance recoverable on unpaid losses and loss expenses (1)
$
10,110

 
$
10,612

Reinsurance recoverable on paid losses and loss expenses (1)
658

 
615

Net reinsurance recoverable on losses and loss expenses
$
10,768

 
$
11,227

Reinsurance recoverable on policy benefits
$
234

 
$
218

(1) 
Net of provision for uncollectible reinsurance



69

We evaluate the financial condition of our reinsurers and potential reinsurers on a regular basis and also monitor concentrations of credit risk with reinsurers. The provision for uncollectible reinsurance is required principally due to the potential failure of reinsurers to indemnify us, primarily because of disputes under reinsurance contracts and insolvencies. The provision for uncollectible reinsurance is based on a default analysis applied to gross reinsurance recoverables, net of approximately $2.4 billion and $2.3 billion of collateral at June 30, 2014 and December 31, 2013, respectively. The decrease in net reinsurance recoverable on losses and loss expenses was primarily due to favorable PPD, crop activity, and collections relating to run-off operations.

Unpaid losses and loss expenses
As an insurance and reinsurance company, we are required by applicable laws and regulations and GAAP to establish loss and loss expense reserves for the estimated unpaid portion of the ultimate liability for losses and loss expenses under the terms of our policies and agreements with our insured and reinsured customers. At June 30, 2014, our gross unpaid loss and loss expense reserves were $37.2 billion and our net unpaid loss and loss expense reserves were $27.1 billion. With the exception of certain structured settlements, for which the timing and amount of future claim payments are reliably determinable, and certain reserves for unsettled claims that are discounted in statutory filings, our loss reserves are not discounted for the time value of money.

The following table presents a roll-forward of our unpaid losses and loss expenses: 
(in millions of U.S. dollars)
Gross
Losses

 
Reinsurance
Recoverable(1)

 
Net
Losses

Balance at December 31, 2013
$
37,443

 
$
10,612

 
$
26,831

Losses and loss expenses incurred
5,466

 
917

 
4,549

Losses and loss expenses paid
(5,937
)
 
(1,491
)
 
(4,446
)
Other (including foreign exchange translation)
205

 
72

 
133

Balance at June 30, 2014
$
37,177

 
$
10,110

 
$
27,067

(1) 
Net of provision for uncollectible reinsurance

The estimate of the liabilities includes provisions for claims that have been reported but are unpaid at the balance sheet date (case reserves) and for obligations on claims that have been incurred but not reported (IBNR) at the balance sheet date. IBNR may also include provisions to account for the possibility that reported claims may settle for amounts that differ from the established case reserves. Loss reserves also include an estimate of expenses associated with processing and settling unpaid claims (loss expenses).

The following table presents our total reserves segregated between case reserves (including loss expense reserves) and IBNR reserves: 
 
June 30, 2014
 
 
December 31, 2013
 
(in millions of U.S. dollars)
Gross

 
Ceded

 
Net

 
Gross

 
Ceded

 
Net

Case reserves
$
15,894

 
$
4,377

 
$
11,517

 
$
16,558

 
$
4,790

 
$
11,768

IBNR reserves
21,283

 
5,733

 
15,550

 
20,885

 
5,822

 
15,063

Total
$
37,177

 
$
10,110

 
$
27,067

 
$
37,443

 
$
10,612

 
$
26,831


Asbestos and Environmental (A&E) and Other Run-off Liabilities
There was no significant A&E reserve activity during the six months ended June 30, 2014. Refer to our 2013 Form 10-K for additional information on A&E and Other Run-off Liabilities.

Fair value measurements
Accounting guidance defines fair value as the price to sell an asset or transfer a liability (an exit price) in an orderly transaction between market participants and establishes a three-level valuation hierarchy based on the reliability of the inputs.

The fair value hierarchy gives the highest priority to quoted prices in active markets (Level 1 inputs) and the lowest priority to unobservable data (Level 3 inputs):

•
Level 1 inputs are unadjusted quoted prices for identical assets or liabilities in active markets.


70


•
Level 2 includes inputs other than quoted prices included within Level 1 that are observable for assets or liabilities either directly or indirectly. Level 2 inputs include, among other items, quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets and liabilities in markets that are not active, and inputs other than quoted prices that are observable for the asset or liability such as interest rates and yield curves.

•
Level 3 inputs are unobservable and reflect our judgments about assumptions that market participants would use in pricing an asset or liability.

We categorize financial instruments within the valuation hierarchy at the balance sheet date based upon the lowest level of inputs that are significant to the fair value measurement. Accordingly, transfers between levels within the valuation hierarchy occur when there are significant changes to the inputs, such as increases or decreases in market activity, changes to the availability of current prices, changes to the transparency to underlying inputs, and whether there are significant variances in quoted prices. Transfers in and/or out of any level are assumed to occur at the end of the period.

While we obtain values for the majority of our investment securities from pricing services, it is ultimately our responsibility to determine whether the values obtained in the financial statements are representative of fair value. We periodically update our understanding of the methodologies used by our pricing services in order to validate that the prices obtained from those services are consistent with the GAAP definition of fair value as an exit price. Based on our understanding of the methodologies, our pricing services only produce an estimate of fair value if there is observable market information that would allow them to make a fair value estimate. Based on our understanding of the market inputs used by our pricing services, all applicable investments have been valued in accordance with GAAP valuation principles. We have controls to review significant price changes and stale pricing, and to ensure that prices received from pricing services have been accurately reflected in the consolidated financial statements. We do not adjust prices obtained from pricing services.

Additionally, fixed maturities valuation is more subjective when markets are less liquid due to the lack of market based inputs (i.e., stale pricing), which may increase the potential that an investment's estimated fair value is not reflective of the price at which an actual transaction would occur. For a small number of fixed maturities, we obtain a quote from a broker (typically a market maker). Due to the disclaimers on the quotes that indicate that the price is indicative only, we include these fair value estimates in Level 3.

At both June 30, 2014 and December 31, 2013, Level 3 assets represented five percent of assets measured at fair value and three percent of total assets. Level 3 liabilities represented 90 percent and 74 percent of liabilities measured at fair value at June 30, 2014 and December 31, 2013, respectively, and less than one percent of our total liabilities at both June 30, 2014 and December 31, 2013. During the three and six months ended June 30, 2014, we transferred assets of $28 million and $32 million into our Level 3 assets from other levels of the valuation hierarchy. During the three and six months ended June 30, 2014, we transferred assets of $16 million and $65 million out of our Level 3 assets to other levels of the valuation hierarchy. Refer to Note 4 to the consolidated financial statements for a description of the valuation techniques and inputs used to determine fair values for our financial instruments measured or disclosed at fair value by valuation hierarchy (Levels 1, 2, and 3) as well as a roll-forward of Level 3 financial instruments measured at fair value for the three and six months ended June 30, 2014 and 2013.

Guaranteed living benefits (GLB) derivatives
Under life reinsurance programs covering living benefit guarantees, we assumed the risk of GLBs associated with variable annuity (VA) contracts. We ceased writing this business in 2007. Our GLB reinsurance product meets the definition of a derivative for accounting purposes and is therefore carried at fair value. We believe that the most meaningful presentation of these derivatives is to reflect cash inflows or revenue as net premiums earned, and to record estimates of the average modeled value of future cash outflows as incurred losses. Accordingly, we recognize benefit reserves consistent with the accounting guidance related to accounting and reporting by insurance enterprises for certain non-traditional long-duration contracts and for separate accounts. Changes in the benefit reserves are reflected as Policy benefits expense, which is included in life underwriting income. The incremental difference between fair value and benefit reserves is reflected in Accounts payable, accrued expenses, and other liabilities in the consolidated balance sheets and related changes in fair value are reflected in Net realized gains (losses) in the consolidated statement of operations. We intend to hold these derivative contracts to maturity (i.e., the expiration of the underlying liabilities through lapse, annuitization, death, or expiration of the reinsurance contract). To partially offset the risk in the VA guarantee reinsurance portfolio, we invest in derivative hedge instruments. At maturity, the cumulative gains and losses will net to zero (excluding cumulative hedge gains or losses) because, over time, the insurance liability will be increased or decreased to equal our obligation. For a sensitivity discussion of the effect of changes in interest


71

rates, equity indices, and other assumptions on the fair value of GLBs, and the resulting impact on our net income, refer to Item 3.

The fair value of GLB reinsurance is estimated using an internal valuation model, which includes current market information and estimates of policyholder behavior from the perspective of a theoretical market participant that would assume these liabilities. All of our treaties contain claim limits, which are factored into the valuation model. The fair value depends on a number of factors, including interest rates, current account value, market volatility, expected annuitization rates and other policyholder behavior, and changes in policyholder mortality. The model and related assumptions are continuously re-evaluated by management and enhanced, as appropriate, based upon additional experience obtained related to policyholder behavior and availability of more timely market information, such as market conditions and demographics of in-force annuities. Due to the inherent uncertainties of the assumptions used in the valuation models to determine the fair value of these derivative products, actual experience may differ from the estimates reflected in our consolidated financial statements, and the differences may be material. For further information on the estimates and assumptions used in determining the fair value of GLB reinsurance, refer to Note 4 to the Consolidated Financial Statements of our 2013 Form 10-K.

ACE Tempest Life Re employs a strategy to manage the financial market and policyholder behavior risks embedded in the reinsurance of VA guarantees. Risk management begins with underwriting a prospective client and guarantee design, with particular focus on protecting our position from policyholder options that, because of anti-selective behavior, could adversely impact our obligation.

A second layer of risk management is the structure of the reinsurance contracts. All VA guarantee reinsurance contracts include some form of annual or aggregate claim limit(s) that would reduce our obligation. For further information on the different categories of claim limits, refer to "Guaranteed living benefits derivatives" in our 2013 Form 10-K under Item 7.

A third layer of risk management is the hedging strategy which looks to mitigate both long-term economic loss over time as well as dampen income statement volatility. ACE Tempest Life Re owned financial market instruments as part of the hedging strategy with a fair value liability of $13 million and $54 million at June 30, 2014 and December 31, 2013, respectively. The instruments are substantially collateralized by our counterparties, on a daily basis.

We also limit the aggregate amount of variable annuity reinsurance guarantee risk we are willing to assume. The last substantive U.S. transaction was quoted in mid-2007 and the last transaction in Japan was quoted in late 2007. The aggregate number of policyholders is currently decreasing at a rate of 7 percent – 15 percent per annum due to policyholder lapses, annuitizations, and deaths.

Note that GLB claims cannot occur for any reinsured policy until it has reached the end of its “waiting period”. The majority of policies we reinsure reach the end of their “waiting periods” in 2014 or later, as shown in the table below.
Year of first payment eligibility
Percent of living benefit
account values

June 30, 2014 and prior
39
%
Remainder of 2014
8
%
2015
6
%
2016
6
%
2017
20
%
2018
14
%
2019
4
%
2020 and after
3
%
Total
100
%


72


The following table presents the historical cash flows under these policies for the periods indicated. The amounts represent accrued past premium received and claims paid, split by benefit type.
 
Three Months Ended
 
 
Six Months Ended
 
 
June 30
 
 
June 30
 
(in millions of U.S. dollars)
2014

 
2013

 
2014

 
2013

Death Benefits (GMDB)
 
 
 
 
 
 
 
Premium
$
18

 
$
20

 
$
37

 
$
40

Less paid claims
9

 
22

 
21

 
42

Net
$
9

 
$
(2
)
 
$
16

 
$
(2
)
Living Benefits (Includes GMIB and GMAB)
 
 
 
 
 
 
 
Premium
$
35

 
$
37

 
$
70

 
$
76

Less paid claims
6

 
6

 
8

 
13

Net
$
29

 
$
31

 
$
62

 
$
63

Total VA Guaranteed Benefits
 
 
 
 
 
 
 
Premium
$
53

 
$
57

 
$
107

 
$
116

Less paid claims
15

 
28

 
29

 
55

Net
$
38

 
$
29

 
$
78

 
$
61


Death Benefits (GMDB)
For premiums and claims from VA contracts reinsuring GMDBs, at current market levels, we expect approximately $40 million of claims and $66 million of premium on death benefits over the next 12 months.

GLB (includes GMIB and GMAB)
Our GLBs predominantly include premiums and claims from VA contracts reinsuring GMIB and GMAB. More than 60 percent of our living benefit reinsurance clients’ policyholders, measured by account value, are currently ineligible to trigger a claim payment. At current market levels, we expect approximately $5 million of claims and $132 million of premium on living benefits over the next 12 months.

Collateral
ACE Tempest Life Re holds collateral on behalf of most of its clients in the form of qualified assets in trust or letters of credit, typically in an amount sufficient for the client to obtain statutory reserve credit for the reinsurance. The timing of the calculation and amount of the collateral varies by client according to the particulars of the reinsurance treaty and the statutory reserve guidelines of the client’s domicile.



73

____________________________________________________________________________________________________________
Catastrophe management

We actively monitor our catastrophe risk accumulation around the world. The table below presents our modeled annual aggregate pre-tax probable maximum loss (PML), net of reinsurance, for 100-year and 250-year return periods for a U.S. hurricane and a California earthquake at June 30, 2014 and 2013. The table also presents ACE’s corresponding share of pre-tax industry losses for each of the return periods for a U.S. hurricane and a California earthquake. For example, according to the model, for the 1-in-100 return period scenario, there is a one percent chance that our losses incurred in any year from a U.S. hurricane could be in excess of $1,745 million (or 5.8 percent of our total shareholders’ equity at June 30, 2014). We estimate that at such hypothetical loss levels, ACE’s share of aggregate industry losses would be approximately 1.1 percent.
 
 
U.S. Hurricane
 
California Earthquake
 
 
 
 
June 30
 
 
 
June 30
 
 
 
June 30
 
 
 
June 30
 
 
 
 
2014
 
 
 
2013
 
 
 
2014
 
 
 
2013
Modeled Annual Aggregate Net PML
 
ACE
 
% of Total
Shareholders’
Equity
 
% of
Industry
 
ACE
 
ACE
 
% of Total
Shareholders’
Equity
 
% of
Industry
 
ACE
(in millions of U.S. dollars, except for percentages)
 
 
 
 
 
 
 
 
 
 
 
 
1-in-100
 
$
1,745

 
5.8
%
 
1.1
%
 
$
1,714

 
$
778

 
2.6
%
 
1.9
%
 
$
802

1-in-250
 
$
2,335

 
7.7
%
 
1.0
%
 
$
2,263

 
$
1,020

 
3.4
%
 
1.6
%
 
$
1,005


The above modeled loss information reflects our in-force portfolio as of April 1, 2014 and reinsurance program effective at July 1, 2014. Effective July 1, 2014, ACE established a new Global Property Catastrophe Program for our North American and International operations that provided global natural catastrophe and terrorism coverage. Refer to "Natural catastrophe property reinsurance program" for additional information.

The modeling estimates of both ACE and industry loss levels are inherently uncertain owing to key assumptions. First, while the use of third-party catastrophe modeling packages to simulate potential hurricane and earthquake losses is prevalent within the insurance industry, the models are reliant upon significant meteorology, seismology, and engineering assumptions to estimate hurricane and earthquake losses. In particular, modeled hurricane and earthquake events are not always a representation of actual events and ensuing additional loss potential. Second, there is no universal standard in the preparation of insured data for use in the models and the running of the modeling software. Third, we are reliant upon third-party estimates of industry insured exposures and there is significant variation possible around the relationship between our loss and that of the industry following an event. Fourth, we assume that our reinsurance recoveries following an event are fully collectible. These loss estimates do not represent our potential maximum exposures and it is highly likely that our actual incurred losses would vary materially from the modeled estimates.

____________________________________________________________________________________________________________
Natural catastrophe property reinsurance program

ACE’s core property catastrophe reinsurance program provides protection against natural catastrophes impacting its primary property operations (i.e., excluding our Global Reinsurance and Life segments).

We regularly review our reinsurance protection and corresponding property catastrophe exposures. This may or may not lead to the purchase of additional reinsurance prior to a program’s renewal date. In addition, prior to each renewal date, we consider how much, if any, coverage we intend to buy and we may make material changes to the current structure in light of various factors, including modeled PML assessment at various return periods, reinsurance pricing, our risk tolerance and exposures, and various other structuring considerations.

ACE established a new Global Catastrophe Program for our North American and International operations. The program is effective July 1, 2014 through June 30, 2015, and consists of two layers in excess of losses retained by ACE. Approximately 20 percent of the coverage was placed with reinsurers providing upfront collateral equal to the limit of their participation and without a reinstatement. The remaining coverage was placed without upfront collateral and with one additional reinstatement limit in the event of a natural peril loss. In addition, we also purchased terrorism coverage (excluding nuclear, biological, chemical and radiation coverage) for the United States from July 1, 2014 to June 30, 2015 with the same limits and retention


74

and percentage placed except that the majority of terrorism coverage is on an aggregate basis above our retentions without a reinstatement.
 
Loss Location
Layer of Loss
Comments
Notes
 
United States
(excluding Alaska and Hawaii)

$0 million - $500 million
Losses retained by ACE
(a)
 
United States
(excluding Alaska and Hawaii)

$500 million - $1.0 billion
All natural perils, and terrorism (excluding nuclear, biological, chemical and radiation)
(b)
 
United States
(excluding Alaska and Hawaii)

$1.0 billion - $1.275 billion
All natural perils, and terrorism (excluding nuclear, biological, chemical and radiation)
(c)
 
International
(including Alaska and Hawaii)

$0 million - $150 million
Losses retained by ACE

(a)
 
International
(including Alaska and Hawaii)

$150 million - $650 million
All natural perils, and terrorism (excluding nuclear, biological, chemical and radiation)
(b)
 
Alaska, Hawaii, and Canada

$650 million - $925 million
All natural perils, and terrorism (excluding nuclear, biological, chemical and radiation)
(c)
 
 
 
 
 
(a) Ultimate retention will depend upon the nature of the loss and the interplay between the underlying per risk programs and certain other catastrophe programs purchased by individual business units. These other catastrophe programs have the potential to reduce our effective retention below the stated levels.
(b) These coverages are both part of the same Core layer within the Global Catastrophe Program and are approximately 90% placed with Reinsurers. As such, it may be exhausted in one region and not available in the other.
(c) These coverages are both part of the same Second layer within the Global Catastrophe Program and are approximately 98% placed with Reinsurers. As such, it may be exhausted in one region and not available in the other.
____________________________________________________________________________________________________________
Crop Insurance
We are, and have been since the 1980s, one of the leading writers of crop insurance in the U.S. and have conducted that business through a managing general agent subsidiary of Rain and Hail. We provide protection throughout the U.S. on a variety of crops and are therefore geographically diversified, which reduces the risk of exposure to a single event or a heavy accumulation of losses in any one region. Our crop insurance business comprises two components – Multiple Peril Crop Insurance (MPCI) and crop-hail insurance.

The MPCI program is offered in conjunction with the U.S. Department of Agriculture (USDA). The policies cover revenue shortfalls or production losses due to natural causes such as drought, excessive moisture, hail, wind, frost, insects, and disease. Generally, policies have deductibles ranging from 10 percent to 50 percent of the insured's risk. The USDA's Risk Management Agency (RMA) sets the policy terms and conditions, rates and forms, and is also responsible for setting compliance standards. As a participating company, we report all details of policies underwritten to the RMA and are party to a Standard Reinsurance Agreement (SRA). The SRA sets out the relationship between private insurance companies and the Federal Crop Insurance Corporation (FCIC) concerning the terms and conditions regarding the risks each will bear including the pro-rata and state stop-loss provisions which allows companies to limit the exposure of any one state or group of states on their underwriting results. In addition to the pro-rata and excess of loss reinsurance protections inherent in the SRA, we also purchase third-party proportional and stop-loss reinsurance for our MPCI business to reduce our exposure. From time to time we may also enter into crop derivative contracts to further manage our risk exposure.

Each year the RMA issues a final SRA for the subsequent reinsurance year. In June 2014, the RMA released the 2015 SRA which establishes the terms and conditions for the 2015 reinsurance year (i.e., July 1, 2014 through June 30, 2015) that replaced the 2014 SRA.  There were no significant changes in the terms and conditions.

On the MPCI business, we recognize net premiums written as soon as estimable, which is generally when we receive acreage reports from the policyholders on the various crops throughout the U.S. This allows us to best determine the premium associated with the liability that is being planted. The MPCI program has specific timeframes as to when producers must report acreage to us and in certain cases, the reporting occurs after the close of the respective reinsurance year. Once the net premium written has been recorded, the premium is then earned over the growing season for the crops. A majority of the crops


75

that are covered in the program are typically subject to the SRA in effect at the beginning of the year. Given the major crops covered in the program, we typically see a substantial written and earned premium impact in the second and third quarters.

The pricing of MPCI premium is determined using a number of factors including commodity prices and related volatility. For instance, in most states the pricing for the MPCI Revenue Product for corn includes a factor that is based on the average price in February of the Chicago Board of Trade December corn futures. To the extent that the corn commodity prices are higher in February than they were in the previous February, and all other factors are the same, the increase in corn prices will increase the corn premium year over year.

Our crop-hail program is a private offering. Premium is earned on the crop-hail program over the coverage period of the policy. Given the very short nature of the growing season, most crop-hail business is typically written in the second and third quarters with the earned premium also more heavily occurring during this time frame. We use industry data to develop our own rates and forms for the coverage offered. The policy primarily protects farmers against yield reduction caused by hail and/or fire, and related costs such as transit to storage. We offer various deductibles to allow the grower to partially self-insure for a reduced premium cost. We limit our crop-hail exposures through the use of township liability limits and third-party proportional and stop-loss reinsurance on our net retained hail business.

______________________________________________________________________________________________________________________
Liquidity
We anticipate that positive cash flows from operations (underwriting activities and investment income) should be sufficient to cover cash outflows under most loss scenarios for the near term. In addition to cash from operations, routine sales of investments, and financing arrangements, we have agreements with a third-party bank provider which implemented two international multi-currency notional cash pooling programs to enhance cash management efficiency during periods of short-term timing mismatches between expected inflows and outflows of cash by currency. The programs allow us to optimize investment income by avoiding portfolio disruption. Should the need arise, we generally have access to capital markets and available credit facilities. At June 30, 2014, our available credit lines totaled $1.4 billion and usage of these credit lines was $648 million. Our access to funds under existing credit facilities is dependent on the ability of the banks that are parties to the facilities to meet their funding commitments. Our existing credit facilities have remaining terms expiring between November 2017 and December 2017 and require that we maintain certain financial covenants, all of which we met at June 30, 2014. We did not renew our $500 million bilateral letter of credit facility that expired in June 2014.  We elected instead to satisfy our collateral obligations primarily with insurance trusts supported by our investment portfolio. Should any of our existing credit providers experience financial difficulty, we may be required to replace credit sources, possibly in a difficult market. If we cannot obtain adequate capital or sources of credit on favorable terms, on a timely basis, or at all, our business, operating results, and financial condition could be adversely affected. To date, we have not experienced difficulty accessing any of our credit facilities. Refer to “Credit Facilities” in our 2013 Form 10-K for additional information.

The payment of dividends or other statutorily permissible distributions from our operating companies are subject to the laws and regulations applicable to each jurisdiction as well as the need to maintain capital levels adequate to support the insurance and reinsurance operations, including financial strength ratings issued by independent rating agencies. During the six months ended June 30, 2014, we were able to meet all of our obligations, including the payments of dividends on our Common Shares, with our net cash flows.

We assess which subsidiaries to draw dividends from based on a number of factors. Considerations such as regulatory and legal restrictions as well as the subsidiary’s financial condition are paramount to the dividend decision. ACE Limited received no dividends from its Bermuda subsidiaries during the six months ended June 30, 2014 and 2013.

The payment of any dividends from AGM or its subsidiaries is subject to applicable U.K. insurance laws and regulations. In addition, the release of funds by Syndicate 2488 to subsidiaries of AGM is subject to regulations promulgated by the Society of Lloyd’s. The U.S. insurance subsidiaries of ACE INA may pay dividends, without prior regulatory approval, subject to restrictions set out in state law of the subsidiary’s domicile (or, if applicable, commercial domicile). ACE INA’s international subsidiaries are also subject to insurance laws and regulations particular to the countries in which the subsidiaries operate. These laws and regulations sometimes include restrictions that limit the amount of dividends payable without prior approval of regulatory insurance authorities. ACE Limited received no dividends from AGM or ACE INA during the six months ended June 30, 2014 and 2013. Debt issued by ACE INA is serviced by statutorily permissible distributions by ACE INA’s insurance subsidiaries to ACE INA as well as other group resources. ACE INA received no dividends from its subsidiaries during the six months ended June 30, 2014 and 2013.



76

Cash Flows
Our sources of liquidity include cash from operations, routine sales of investments, and financing arrangements. The following is a discussion of our cash flows for the six months ended June 30, 2014 and 2013.

Operating cash flows were $2.1 billion in the six months ended June 30, 2014, compared with $1.8 billion in the prior year period, primarily due to $569 million of higher net premiums collected, partially offset by higher losses paid of $267 million.

Cash used for investing was $1.5 billion in the six months ended June 30, 2014, compared with $2.4 billion in the prior year period. The decrease in cash flows used for investing activities was primarily due to cash paid for acquisitions in the prior year of $977 million compared with $172 million in the current year. Refer to Note 2 to the Consolidated Financial Statements for additional information on our acquisitions.

Cash used for financing was $625 million in the six months ended June 30, 2014, compared with cash flows from financing of $658 million in the prior year period. Financing cash flows for the six months ended June 30, 2014 included $500 million of repayments of long-term debt, $557 million of share repurchases, and $428 million of dividends paid on Common Shares, partially offset by proceeds from the issuance of long-term debt of $699 million. Cash flows from financing for the six months ended June 30, 2013 included $947 million of proceeds from the issuance of long-term debt, partially offset by $212 million of share repurchases and $169 million of dividends paid on Common Shares. Dividends paid were lower in the prior year due to the accelerated payment of the fourth quarter 2012 dividend in December 2012, which would normally have been paid during the first quarter 2013.

Both internal and external forces influence our financial condition, results of operations, and cash flows. Claim settlements, premium levels, and investment returns may be impacted by changing rates of inflation and other economic conditions. In many cases, significant periods of time, ranging up to several years or more, may lapse between the occurrence of an insured loss, the reporting of the loss to us, and the settlement of the liability for that loss.

In the current low interest rate environment, we use repurchase agreements as a low-cost alternative for short-term funding needs and to address short-term cash timing differences without disrupting our investment portfolio holdings. At June 30, 2014, there were $1.4 billion in repurchase agreements outstanding.

__________________________________________________________________________________________________________
Capital Resources
Capital resources consist of funds deployed or available to be deployed to support our business operations.
 
June 30

 
December 31

(in millions of U.S. dollars, except for percentages)
2014

 
2013

Short-term debt
$
1,851

 
$
1,901

Long-term debt
4,057

 
3,807

Total debt
5,908

 
5,708

Trust preferred securities
309

 
309

Total shareholders’ equity
30,325

 
28,825

Total capitalization
$
36,542

 
$
34,842

Ratio of debt to total capitalization
16.2
%
 
16.4
%
Ratio of debt plus trust preferred securities to total capitalization
17.0
%
 
17.3
%

In May 2014, we reclassified $450 million of 5.6 percent senior notes, due to mature on May 15, 2015, from Long-term debt to Short-term debt in the consolidated balance sheet. In May 2014, we issued $700 million of 3.35 percent senior notes due May 2024. The proceeds from the debt issuance are expected to be used to repay at maturity the $700 million of 2.6 percent senior notes due November 2015. In June 2014, ACE INA Holdings Inc.'s $500 million of 5.875 percent senior notes matured and were fully paid.



77

The following table presents the significant movements in our shareholders’ equity: 
 
 
Six Months Ended

(in millions of U.S. dollars)
 
June 30, 2014

Balance – beginning of period
 
$
28,825

Net income
 
1,513

Net unrealized appreciation on investments, net of tax
 
873

Repurchase of shares
 
(569
)
Dividends on Common Shares
 
(479
)
Change in cumulative translation, net of tax
 
78

Exercise of stock options
 
48

Other movements, net of tax
 
36

Balance – end of period
 
$
30,325


For the six months ended June 30, 2014 and 2013, we repurchased $569 million and $212 million, respectively, of Common Shares in a series of open market transactions under existing Board authorizations. As of June 30, 2014, $1.37 billion in repurchase authorization remained through December 31, 2014. Refer to Note 8 to the Consolidated Financial Statements for additional information on the repurchase authorization. As of June 30, 2014, there were 6,606,823 Common Shares in treasury with a weighted average cost of $95.30 per share. For the period July 1, 2014 through July 29, 2014, we repurchased 1,281,630 Common Shares for a total of $133 million in a series of open market transactions. At July 29, 2014, $1.24 billion in share repurchase authorization remained through December 31, 2014.

We generally maintain the ability to issue certain classes of debt and equity securities via an unlimited Securities and Exchange Commission (SEC) shelf registration which is renewed every three years. This allows us capital market access for refinancing as well as for unforeseen or opportunistic capital needs. Our current shelf registration on file with the SEC expires in December 2014.

Dividends
We have paid dividends each quarter since we became a public company in 1993. Under Swiss law, dividends must be stated in Swiss francs though dividend payments are made by ACE in U.S. dollars. Refer to Note 8 to the Consolidated Financial Statements for a discussion of our dividend methodology. At our May 2013 annual general meeting, our shareholders approved an annual dividend distribution for the following year by way of a par value reduction equal to $2.04 per share, or CHF 1.92 per share, calculated using the USD/CHF exchange rate as published in the Wall Street Journal on May 10, 2013. The annual dividend approved in May 2013 was paid in four quarterly installments, in accordance with the shareholder resolution.

At the January 10, 2014 Extraordinary General Meeting, our shareholders approved a resolution to increase our quarterly dividend 24 percent from $0.51 per share to $0.63 per share for the payment made on January 31, 2014 and April 17, 2014, with the $0.12 per share increase for each installment distributed from capital contribution reserves (and the $0.51 per share distributed by way of par value reduction).

At our May 2014 annual general meeting, our shareholders approved an annual dividend distribution for the following year by way of a par value reduction equal to $2.60 per share, or CHF 2.28 per share, calculated using the USD/CHF exchange rate as published in the Wall Street Journal on May 9, 2014, payable in four quarterly installments.

The following table represents dividends paid per Common Share to shareholders of record on each of the following dates: 
Shareholders of record as of:
 
Dividends paid as of:
 
 
January 13, 2014
 
January 31, 2014
 
$0.63 (CHF 0.55)
March 28, 2014
 
April 17, 2014
 
$0.63 (CHF 0.55)
July 23, 2014
 
August 13, 2014
 
$0.65 (CHF 0.58)


78

ITEM 3. Quantitative and Qualitative Disclosures about Market Risk
Refer to Item 7A included in our 2013 Form 10-K.

Reinsurance of GMDB and GLB guarantees
Net income is directly impacted by changes in benefit reserves calculated in connection with reinsurance of variable annuity guarantees, primarily GMDB and GLB. Benefit reserves are calculated in accordance with guidance related to accounting and reporting by insurance enterprises for certain non-traditional long-duration contracts and for separate accounts. Changes in benefit reserves are reflected as policy benefits expense, which is included in life underwriting income. In addition, net income is directly impacted by the change in the fair value of the GLB liability (FVL), which is classified as a derivative for accounting purposes. The FVL established for a GLB reinsurance contract represents the difference between the fair value of the contract and the benefit reserves. Changes in the FVL, net of associated changes in the calculated benefit reserves, are reflected as realized gains or losses.

ACE views its variable annuity reinsurance business as having a similar risk profile to that of catastrophe reinsurance with the probability of long-term economic loss relatively small, at the time of pricing. Adverse changes in market factors and policyholder behavior will have an impact on both life underwriting income and net income. When evaluating these risks, we expect to be compensated for taking both the risk of a cumulative long-term economic net loss, as well as the short-term accounting variations caused by these market movements. Therefore, we evaluate this business in terms of its long-term economic risk and reward.

At June 30, 2014, management established benefit reserves based on the benefit ratio calculated using assumptions reflecting management’s best estimate of the future performance of the variable annuity line of business. Management exercises judgment in determining the extent to which short-term market movements impact the benefit reserves. The benefit reserves are based on the calculation of a long-term benefit ratio (or loss ratio) for the variable annuity guarantee reinsurance. Despite the long-term nature of the risk, the benefit ratio calculation is impacted by short-term market movements that may be judged by management to be temporary or transient. Management’s best estimate reflected a judgment that the equity markets will exhibit growth somewhat lower than historical average levels. Management regularly examines both quantitative and qualitative analysis and for the quarter ended June 30, 2014, determined that no change to the benefit ratio was warranted.

The guidance requires us to “regularly evaluate estimates used and adjust the liability balance... if actual experience or other evidence suggests that earlier assumptions should be revised.” ACE evaluates its estimates regularly and management uses judgment to determine the extent to which assumptions underlying the benefit ratio calculation used to establish benefit reserves should be adjusted. The benefit ratio is calculated based on management’s expectation for the short-term and long-term performance of the variable annuity guarantee liability. Management’s quantitative analysis includes a review of the differential between the benefit ratio used at the most recent valuation date and the benefit ratio calculated on subsequent dates.

Benefit reserves and FVL calculations are directly affected by market factors, including equity levels, interest rate levels, credit risk, and implied volatilities, as well as policyholder behaviors, such as annuitization and lapse rates. The tables below assume no changes to the benefit ratio used to establish benefit reserves at June 30, 2014 and show the sensitivity, at June 30, 2014, of the FVL associated with the variable annuity guarantee reinsurance portfolio. In addition, the tables below present the sensitivity of the fair value of specific derivative instruments held (hedge value) to partially offset the risk in the variable annuity guarantee reinsurance portfolio. The tables below are estimates of the sensitivities to instantaneous changes in economic inputs or actuarial assumptions.

The tables below do not reflect the expected quarterly run rate of net income generated by the variable annuity guarantee reinsurance portfolio if markets remain unchanged during the period. All else equal, if markets remain unchanged during the period, the Gross FVL will increase, resulting in a realized loss. The realized loss occurs primarily because, during the period, we will collect premium while paying little or no claims on our GLB reinsurance (since most policies are not eligible to annuitize until after June 30, 2014). This increases the Gross FVL because future premiums are lower by the amount collected in the quarter, and also because future claims are discounted for a shorter period. We refer to this increase in Gross FVL as “timing effect”. The unfavorable impact of timing effect on our Gross FVL in a quarter is not reflected in the sensitivity tables below. For this reason, when using the tables below to estimate the sensitivity of Gross FVL in the third quarter to various changes, it is necessary to assume an additional $5 million to $45 million increase in Gross FVL and realized losses. However, the impact to Net income is substantially mitigated because this realized loss is expected to be exceeded by the positive quarterly run rate of life underwriting income generated by the variable annuity guarantee reinsurance portfolio if markets remain unchanged during


79

the period. Note that both the timing effect and the quarterly run rate of life underwriting income change over time as the book ages.
Interest Rate Shock
Worldwide Equity Shock
(in millions of U.S. dollars)
+10%
 
Flat
 
-10%
 
-20%
 
-30%
 
-40%
+100 bps
(Increase)/decrease in Gross FVL
$
294

 
$
186

 
$
20

 
$
(251
)
 
$
(609
)
 
$
(1,069
)
 
Increase/(decrease) in hedge value
(148
)
 
—

 
149

 
300

 
456

 
619

 
Increase/(decrease) in net income
$
146

 
$
186

 
$
169

 
$
49

 
$
(153
)
 
$
(450
)
Flat
(Increase)/decrease in Gross FVL
$
184

 
$
—

 
$
(268
)
 
$
(613
)
 
$
(1,054
)
 
$
(1,583
)
 
Increase/(decrease) in hedge value
(148
)
 
—

 
149

 
301

 
457

 
620

 
Increase/(decrease) in net income
$
36

 
$
—

 
$
(119
)
 
$
(312
)
 
$
(597
)
 
$
(963
)
-100 bps
(Increase)/decrease in Gross FVL
$
(74
)
 
$
(335
)
 
$
(671
)
 
$
(1,098
)
 
$
(1,618
)
 
$
(2,213
)
 
Increase/(decrease) in hedge value
(148
)
 
—

 
150

 
302

 
459

 
623

 
Increase/(decrease) in net income
$
(222
)
 
$
(335
)
 
$
(521
)
 
$
(796
)
 
$
(1,159
)
 
$
(1,590
)
 
 
 
 
 
 
 
 
 
 
 
 
 
Sensitivities to Other Economic Variables
AA-rated Credit Spreads
 
 Interest Rate Volatility
 
 Equity Volatility
(in millions of U.S. dollars)
+100
 
-100
 
+2%
 
-2%
 
+2%
 
-2%
(Increase)/decrease in Gross FVL
$
49

 
$
(53
)
 
$
(1
)
 
$
—

 
$
(22
)
 
$
20

Increase/(decrease) in hedge value
—

 
—

 
—

 
—

 
1

 
(1
)
Increase/(decrease) in net income
$
49

 
$
(53
)
 
$
(1
)
 
$
—

 
$
(21
)
 
$
19

 
 
 
 
 
 
 
 
 
 
 
 
Sensitivities to Actuarial Assumptions
 
 
 
 
Mortality
(in millions of U.S. dollars)
 
 
 
 
+20%
 
+10%
 
-10%
 
-20%
(Increase)/decrease in Gross FVL
 
 
 
 
$
20

 
$
10

 
$
(10
)
 
$
(21
)
Increase/(decrease) in hedge value
 
 
 
 
—

 
—

 
—

 
—

Increase/(decrease) in net income
 
 
 
 
$
20

 
$
10

 
$
(10
)
 
$
(21
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Lapses
(in millions of U.S. dollars)
 
 
 
 
+50%
 
+25%
 
-25%
 
-50%
(Increase)/decrease in Gross FVL
 
 
 
 
$
159

 
$
90

 
$
(118
)
 
$
(249
)
Increase/(decrease) in hedge value
 
 
 
 
—

 
—

 
—

 
—

Increase/(decrease) in net income
 
 
 
 
$
159

 
$
90

 
$
(118
)
 
$
(249
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Annuitization
(in millions of U.S. dollars)
 
 
 
 
+50%
 
+25%
 
-25%
 
-50%
(Increase)/decrease in Gross FVL
 
 
 
 
$
(237
)
 
$
(131
)
 
$
130

 
$
227

Increase/(decrease) in hedge value
 
 
 
 
—

 
—

 
—

 
—

Increase/(decrease) in net income
 
 
 
 
$
(237
)
 
$
(131
)
 
$
130

 
$
227


The above tables assume equity shocks impact all global equity markets equally and that the interest rate shock is a parallel shift in the U.S. yield curve. Our liabilities are sensitive to global equity markets in the following proportions: 70 percent—80 percent U.S. equity, 10 percent—20 percent international equity ex-Japan, 5 percent—15 percent Japan equity. Our current hedge portfolio is sensitive to global equity markets in the following proportions: 100 percent U.S. equity. We would suggest using the S&P 500 index as a proxy for U.S. equity, the MSCI EAFE index as a proxy for international equity, and the TOPIX as a proxy for Japan equity.

Our liabilities are also sensitive to global interest rates at various points on the yield curve, mainly the U.S. Treasury curve in the following proportions: 0 percent—10 percent short-term rates (maturing in less than 5 years), 20 percent—30 percent medium-term rates (maturing between 5 years and 10 years, inclusive), and 65 percent—75 percent long-term rates (maturing


80

beyond 10 years). A change in AA-rated credit spreads (AA-rated credit spreads are a proxy for both our own credit spreads and the credit spreads of the ceding insurers) impacts the rate used to discount cash flows in the fair value model. The hedge sensitivity is from June 30, 2014 market levels.

The above sensitivities are not directly additive because changes in one factor will affect the sensitivity to changes in other factors. Also, the sensitivities do not scale linearly and may be proportionally greater for larger movements in the market factors. Sensitivities may also vary due to foreign exchange rate fluctuations. The calculation of the FVL is based on internal models that include assumptions regarding future policyholder behavior, including lapse, annuitization, and asset allocation. These assumptions impact both the absolute level of the FVL as well as the sensitivities to changes in market factors shown above. Additionally, actual sensitivity of our net income may differ from those disclosed in the tables above due to differences between short-term market movements and management judgment regarding the long-term assumptions implicit in our benefit ratios. Furthermore, the sensitivities above could vary by multiples of the sensitivities in the tables above.

Variable Annuity Net Amount at Risk
The tables below present the net amount at risk at June 30, 2014 following an immediate change in equity market levels, assuming all global equity markets are impacted equally. For further information on the net amount at risk, refer to Note 5 to the Consolidated Financial Statements.

a) Reinsurance covering the GMDB risk only
 
Equity Shock
(in millions of U.S. dollars, except percentages)
+20%
 
Flat
 
-20%
 
-40%
 
-60%
 
-80%
GMDB net amount at risk
$
427

 
$
601

 
$
1,078

 
$
1,656

 
$
1,707

 
$
1,463

Claims at 100% immediate mortality
823

 
676

 
386

 
291

 
265

 
241


The treaty claim limits function as a ceiling on the net amount at risk as equity markets fall. In addition, the claims payable if all of the policyholders were to die immediately declines as equity markets fall due to the specific nature of these claim limits, many of which are annual claim limits calculated as a percentage of the reinsured account value. There is also some impact due to a small portion of the GMDB reinsurance under which claims are positively correlated to equity markets (claims decrease as equity markets fall).

b) Reinsurance covering the GLB risk only
 
Equity Shock
(in millions of U.S. dollars, except percentages)
+20%
 
Flat
 
-20%
 
-40%
 
-60%
 
-80%
GLB net amount at risk
$
64

 
$
173

 
$
684

 
$
1,633

 
$
2,346

 
$
2,835


The treaty claim limits cause the net amount at risk to increase at a declining rate as equity markets fall.

c) Reinsurance covering both the GMDB and GLB risks on the same underlying policyholders
 
Equity Shock
(in millions of U.S. dollars, except percentages)
+20%
 
Flat
 
-20%
 
-40%
 
-60%
 
-80%
GMDB net amount at risk
$
44

 
$
69

 
$
106

 
$
146

 
$
180

 
$
208

GLB net amount at risk
51

 
142

 
478

 
1,098

 
1,745

 
2,273

Claims at 100% immediate mortality
21

 
64

 
369

 
612

 
821

 
1,012


The treaty limits control the increase in the GMDB net amount at risk as equity markets fall. The GMDB net amount at risk continues to grow as equity markets fall because most of these reinsurance treaties do not have annual claim limits calculated as a percentage of the underlying account value.

The treaty limits cause the GLB net amount at risk to increase at a declining rate as equity markets fall.



81

ITEM 4. Controls and Procedures
ACE’s management, with the participation of ACE’s Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of ACE’s disclosure controls and procedures as defined in Rule 13a-15(e) and Rule 15d-15(e) under the Securities Exchange Act of 1934 as of June 30, 2014. Based upon that evaluation, ACE’s Chief Executive Officer and Chief Financial Officer concluded that ACE’s disclosure controls and procedures are effective in allowing information required to be disclosed in reports filed under the Securities and Exchange Act of 1934 to be recorded, processed, summarized, and reported within time periods specified in the rules and forms of the SEC, and that such information is accumulated and communicated to ACE’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

There has been no change in ACE’s internal controls over financial reporting during the three months ended June 30, 2014 that has materially affected, or is reasonably likely to materially affect, ACE’s internal controls over financial reporting.

PART II OTHER INFORMATION

ITEM 1. Legal Proceedings
The information required with respect to this item is included in Note 7 e) to the Consolidated Financial Statements which is hereby incorporated by reference.

ITEM 1A. Risk Factors

Refer to “Risk Factors” under Item 1A of Part I of our 2013 Form 10-K. There have been no material changes to the risk factors disclosed in Item 1A of Part I of our 2013 Form 10-K.

ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds and Issuer Repurchases of Equity Securities

Issuer’s Repurchases of Equity Securities
The following table provides information with respect to purchases by ACE of its Common Shares during the three months ended June 30, 2014:
Period
Total
Number of
Shares
Purchased(1)

 
Average Price Paid per Share

 
 Total Number of Shares Purchased as Part of Publicly Announced Plan(2)

 
Approximate
Dollar Value of 
Shares that May
Yet be Purchased 
Under the Plan(3)

April 1 through April 30
502,368

 
$
100.04

 
501,000

 
$
1,562
 million
May 1 through May 31
733,632

 
$
102.69

 
630,000

 
$
1,497
 million
June 1 through June 30
1,175,988

 
$
104.17

 
1,175,000

 
$
1,374
 million
Total
2,411,988

 
 
 
2,306,000

 
 
 
(1) 
This column primarily represents open market share repurchases. Other activity during the three months ended June 30, 2014 is related to the surrender to ACE of Common Shares to satisfy tax withholding obligations in connection with the vesting of restricted stock issued to employees and the exercising of options by employees.
(2) The aggregate value of shares purchased in the three months ended June 30, 2014 as part of the publicly announced plan was $237 million.
(3) 
Refer to Note 8 to the Consolidated Financial Statements for more information on the ACE Limited securities repurchase authorization. For the period July 1, 2014 through July 29, 2014, we repurchased 1,281,630 Common Shares for a total of $133 million in a series of open market transactions. At July 29, 2014, $1.24 billion in share repurchase authorization remained through December 31, 2014.


ITEM 6. Exhibits
Refer to the Exhibit Index.


82

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
ACE LIMITED
 
(Registrant)
 
 
July 30, 2014
/s/ Evan G. Greenberg
 
Evan G. Greenberg
 
Chairman, President, and Chief Executive Officer
 
 
July 30, 2014
/s/ Philip V. Bancroft
 
Philip V. Bancroft
 
Chief Financial Officer




83

 
 
 
 
Incorporated by Reference
 
 
Exhibit
Number
 
Exhibit Description
 
Form
 
Original
Number
 
Date Filed
 
Filed
Herewith
3.1
 
Articles of Association of the Company, as amended and restated
 
8-K
 
3
 
July 24, 2014
 
 
 
 
 
 
 
 
 
 
 
 
 
3.2
 
Organizational Regulations of the Company, as amended and restated
 
8-K
 
3
 
August 16, 2013
 
 
 
 
 
 
 
 
 
 
 
 
 
4.1
 
Articles of Association of the Company, as amended and restated
 
8-K
 
4
 
July 24, 2014
 
 
 
 
 
 
 
 
 
 
 
 
 
4.2
 
Organizational Regulations of the Company, as amended and restated
 
8-K
 
4
 
August 16, 2013
 
 
 
 
 
 
 
 
 
 
 
 
 
4.3
 
Form of 3.35 percent Senior Notes due 2024
 
8-K

 
4.1
 
May 27, 2014
 
 
 
 
 
 
 
 
 
 
 
 
 
31.1
 
Certification Pursuant to Section 302 of The Sarbanes-Oxley Act of 2002
 
 
 
 
 
 
 
X
 
 
 
 
 
 
 
 
 
 
 
31.2
 
Certification Pursuant to Section 302 of The Sarbanes-Oxley Act of 2002
 
 
 
 
 
 
 
X
 
 
 
 
 
 
 
 
 
 
 
32.1
 
Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of The Sarbanes-Oxley Act of 2002
 
 
 
 
 
 
 
X
 
 
 
 
 
 
 
 
 
 
 
32.2
 
Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of The Sarbanes-Oxley Act of 2002
 
 
 
 
 
 
 
X
 
 
 
 
 
 
 
 
 
 
 
101.1
 
The following financial information from ACE Limited’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2014 formatted in XBRL: (i) Consolidated Balance Sheets at June 30, 2014, and December 31, 2013; (ii) Consolidated Statements of Operations and Comprehensive Income for the three and six months ended June 30, 2014 and 2013; (iii) Consolidated Statements of Shareholders’ Equity for the six months ended June 30, 2014 and 2013; (iv) Consolidated Statements of Cash Flows for the six months ended June 30, 2014 and 2013; and (v) Notes to Consolidated Financial Statements
 
 
 
 
 
 
 
X




84